Performance after the Wall Street Crash of 1829

Performance of the Mutual Funds Industry in India


Literature Review

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to the Subject

            A mutual fund, according to the Economic Times,
is a professionally-managed investment scheme, usually run by an asset
management company that brings together a group of people and invests their
money in stocks, bonds and other securities. It has various benefits as well as
drawbacks as compared to the conventional method of direct investment in
individual securities. On one hand, an investment in mutual funds provides
returns on a certain scale, has higher levels of diversification, provides
liquidity to the investor, and is managed by professional investors, who
constantly study and analyse the investment market for optimum results; on the
other, mutual funds are accompanied with economic risks, determined by the
ever-fluctuating market, as well as the various expenses and fees attached with
the managers of the investor’s funds.

funds have remained a lucrative front for investments since their inception
during the financial crisis of 1772-73, by Abraham van Ketwich. Present in the
investment markets of the United States from 1890s, mutual funds were formally
regulated after the Wall Street Crash of 1829 by the US Congress. The current
market has since grown to a global estimate of $ 40.4 trillion at the end of
2016, according to the Investment Company Institute.

funds emerged in 1963 in India, with the establishment of the Unit Trust of
India (UTI), an initiative undertaken by the Government of India alongside the
Reserve Bank of India. SBI Mutual Fund, by the State Bank of India, was the
first non-UTI mutual fund to be introduced in the subcontinent. The Securities
and Exchange Board of India (SEBI) Act, passed in 1992, permitted the entry of
private companies into the investment market. The current Indian market values
at $ 2.2 trillion, according to the Association of Mutual Funds in India.


to the Research

A researcher should have preliminary orientation
and background knowledge about the subject under discussion, and should collect
the basic concepts and information regarding the same. Due to these reasons the
review of the literature has an important role in research study.

the importance of mutual funds, several academicians have tried to study the
performance of various funds. Initially, their studies have focused on timing
and investment abilities of fund managers. Later, several researchers have
tried to study the various factors and their impact on fund performance. These
factors include potential measurement errors from survivorship bias and
misspecification of the benchmark, the impact of fund expenses and economies of
scale, to the personal characteristics of fund managers. Various studies that
focused on factors such as the ability of fund managers to consistently
outperform the market and the fund specific organizational and managerial aspects
came out with contradictory conclusions.


2.1. Mutual Fund Performance and the Effects on the Market

Michael C. Jensen’s “The Performance of Mutual
Funds in the Period 1945-64” (1968) analysed the mutual fund performance of 115
funds over a period spanning from 1945 to 1964, confirmed the efficient market
hypothesis. His analysis has shown that the performance of expense-adjusted
fund returns was markedly lower than those randomly chosen portfolios of a
similar risk category. These results were in sync with the findings of Jack L.
Treynor and William F. Sharpe, in the Capital Asset Pricing Model (CAPM), a
model used to determine the theoretically-appropriate required rate of return
of an asset. Sharpe also looked at the performance of open-end mutual funds and
found that to a major extent the capital market is highly efficient, but there
is some evidence of persistence in performance. Performance of professionally
managed funds also was not any better than the performance of risk-adjusted index
portfolio, which also indicated that managers of these funds did not appear to
possess private information. Thus, the results of the early studies prevailed
as general conclusions in the erstwhile literature.

            However, a
number of later studies on the subject, nonetheless, went against the early
findings. For instance, a study by Richard A. Ippolito, in The Quarterly
Journal of Economics (1989), found mutual fund returns after expenses
(before loads) to be superior than the returns offered by risk-adjusted market
indices, which indicated that mutual fund managers may have access to the
useful private information. He concluded that risk-adjusted returns in the
mutual fund industry, net of fees and expenses, are comparable to returns
available in index funds.  Thus, the
mutual fund managers may produce such excess returns that can offset the
expenses of the fund.

studies by Grinblatt and Titman (1992), Hendricks, Patel and Zeckhauser (1993),
Goetzn-iann and Ibbotson (1994), and Voikman and Wohar (1995), were in support
of market efficiency as they discovered instances of repeated winners amongst
fund managers. Recently, Russ Wermers’s “Mutual fund performance: An empirical
decomposition into stock-picking talent, style, transactions costs, and expenses”
(2000) decomposed mutual fund returns into a stock picking talent; features of
stockholding and trading costs and expenses. The decomposition helped Wermer
show that stock picking of funds, in fact, enabled the managers to cover their

Other studies by Elton, Gruber. Das and Hlavka
(1993), Malkiel (1995) and Carhart (1997) reinforced the early conclusion of
Jensen (1968). While doing away with survivorship bias, Mark M. Carhart, in his
“On persistence in mutual fund performance” (1997), has shown that the common
factors that drive stock returns are responsible for consistency in mutual fund

            On the
other hand Burton Malkiel’s studies consider both benchmark errors and
survivorship bias, and conclude that the previous results indicating market
inefficiency were affected by these factors.


2.2. Performance Measurement and Global Returns

Performance Measurement plays an important role
for investors when deciding to invest in mutual funds. Since Harry Markowitz’s
study on Portfolio Selection, in The Journal of Finance (1952), several
indicators have been developed to assess fund performance. Traditional
indicators are accompanied by the measures that evaluate conditions such as
asset allocation and performance persistence. The rising number of indicators
might lead to a more confused performance evaluation as the use of the
innumerable indicators can lead to wavering results and varying fund rankings.

Hery Razafitombo, in “A Statistical Analysis of
Mutual Fund Performance Measures: The Relevance of IR, Betas and Sharpe Ratios”
(2011), noted that there was ample academic literature on performance
measurement, though few studies contrasted between the various measures.

In the study, the author chose 15 performance measures:
Jensen’s ‘alpha’, ‘beta’, ‘bull-beta’, ‘bear-beta’, ‘absolute performance’,
‘relative performance’, ‘number of negative periods’, ‘number of positive
periods’, ‘standard deviation’, ‘maximum drawdown’, ‘tracking error’,
‘information ratio’, ‘Sharpe ratio’, ‘Treynor ratio’ and ‘Sortino ratio’; and,
tried to recognize which ones were the most relevant ones for evaluating mutual
funds. Using a sample of 210 equity mutual funds from the Reuters-Lipper
database, he examined their statistical properties, over the phase from 2000 to
2006, and noted that his investigations were clearly comprehensive, associated
to other studies, as he conducted the three-step tests.

These results showed that correlations between
the various measures are changing over time and are rather weak. From this, an
inference could be made that all these performance indicators are worth
considering as they bring complementary information to the investors. Amongst
the performance measurement indicators considered in this study, the ‘performance
analysis’, i.e., the market exposure, the relative performance, and the
manager’s skilfulness and quality of tracking, especially highlights the
significance of ‘information ratios’, ‘betas’ and ‘Sharpe ratios’ to evaluate
these three dimensions. Above all, the main conclusion of the author was that
‘performance analysis’ should be usefully performed with a multi-criteria
approach integrating all its various aspects, i.e., including calculations over
different time periods (short term, medium term and long term), and including
the three dimensions of performance evaluation (relative performance, beta
exposure and manager skill).

The results found in the literature were
controversial: certain studies found no convergence amid funds’ rankings obtained
with numerous measures (Plantinga and De Groot, (2001)); others reached unlikely
conclusions, such as convergence amongst a group of measures, nonetheless with
the Sharpe ratio, which measures the relationship between the risk premium and
the standard deviation of the returns generated by a fund, standing apart
(Hwang and Salmon (2002)). A. Plantinga and S. De Groot, in their “Risk-Adjusted
Performance Measures and Implied Risk-Attitudes” (2001), examine to what extent
performance measures can be used as alternatives for preference functions. The
study consisted of ‘Sharpe ratio, ‘Sharpe’s alpha’, ‘the expected return
measure’, ‘the Fouse index’, ‘the Sortino ratio’ and ‘the upside potential
ratio’. It was found that the first three measures corresponded to the
inclinations of investors with a low degree of risk aversion, while the latter
three measures matched the preferences of investors with medium and higher
degrees of risk aversion. Therefore, the choice of the suitable performance
measure should be determined by the preference function of the investor.

C.S. Pedersen and T. Rudholm-Alfvin, in “Selecting
a risk-adjusted shareholder performance measure” (2003), and Martin Eling and
Frank Schuhmacher, in “Does the choice of performance measure influence the
evaluation of hedge funds?” (2007), also accomplished the convergence between
the ranks produced by numerous measures, and recognize the Sharpe ratio as
exhibiting dominance to establish the ranking.

The choice of a ‘performance measure’ may also
be justified by other considerations. A frequently used justification of a
performance measure is its ability to identify the investment skills of
portfolio managers. An interesting contribution to this discussion is by
Kothari and Warner (2001), which focused on the capability of numerous
risk-adjusted performance measures, such as the ‘Sharpe ratio’ and the ‘Jensen’s
alpha’, to identify investment skills, and concluded that the performance
measures have important difficulties in detecting investment skills.

Redman, Gullett and Manakyan, in “The
performance of global and international mutual fund” (2000), evaluated the
risk-adjusted returns using ‘Treynor ratio’, ‘Sharpe ratio’, and ‘Jensen’s alpha’,
for 5 portfolios of global mutual funds and for three time periods of nine and
four years (1985-1994, 1985-1989, and 1990-1994), with the benchmark of the
Vanguard Index 500. During the first and second time frame, the portfolios
performed better than the U.S. markets; however, during the third time frame,
the earnings fell below the U.S. index.

A study by Noulas and John (2005) surveyed the
performance of 23 Greek equity funds amid the years 1997-2000 on a weekly
basis. The performance was evaluated and ranked using the ratios of Treynor,
Sharpe and Jensen. The results showed that the beta of all funds was less than
one for four-year period establishing that the equity funds had neither like
risks nor the same return.

On a global front, “Empirical Analysis of
International Mutual Fund performance”, a study by Suzanne and Boudreaux (2007),
analysed ten sample portfolios of global mutual funds and examined the returns
by using ‘Sharpe’s ratio’ for the time frame of 2000-2006. Nine out of ten of
the sample mutual funds under study performed better than the benchmarked U.S.
market. The portfolios which comprised of all global mutual funds did better
than the portfolio which had only U.S. stock mutual funds.


2.3. Performance Measurement and the Indian Perspectives

Using the ‘Modigliani and Modigliani (m-squared)’
performance measure, Onur Arugaslan and Ajay Samant evaluated 50 extensive U.S.
global equity funds a ten-year period of 1994-2003, in their study “Evaluating
large US?based equity mutual funds using risk?adjusted performance measures” (2008). The
results showed that risk effected the attractiveness of the fund as even though
the funds had greater returns funds, they did lose attractiveness amongst the
investors due to superior risk whereas the lesser return funds were attractive
due to the minority of the risk.

Sathya Swaroop Debashish measured the
performance of equity based mutual funds in India, in his study “Investigating
Performance of Equity-based Mutual Fund Schemes in Indian Scenario”, published
in the KCA Journal of Business Management (2009). He perused 23 schemes
over a period of 13 years, from April 1996 to March 2009, using various risk
adjusted measures. The results show that ‘UTI’, ‘Franklin Templeton’, ‘Prudential
ICICI’ (in the private sector) and ‘SBI’, have all out-performed the market portfolio
with positive values, while the ‘Birla Sunlife’, ‘HDFC’ and ‘LIC’ mutual funds
showed a poor below-average performance, when amounted against the risk-return
relationship models and measures. “Performance analysis of Indian mutual funds
with a special reference to sector funds” (2011), a study by B. Ramesh and P.S.S.
Dhume, analysed the performance of sector funds which were located within the
domains of banking, infrastructure, ‘FMCG’, technology and pharmaceuticals. The
study focused on different performance measures, the findings of which
discovered that, except the infrastructure sector funds, all the other funds
had outpaced the market.

R. Anitha (2011) assessed the performance of
private and public sector mutual funds for a period of two years (2005-2007),
along with C. Radhapriya and T. Devasenathipathi. Selected funds were studied
using statistical measures like ‘mean’, ‘variance’, ‘co-variance’ and ‘standard
deviation’. The performance of all the selected funds has exhibited volatility
during period of study, leading to the difficult situation of assigning one
particular fund that would outperform the others consistently. M.K. Patel and K.P.
Prajapati (2012) estimated the performance of mutual funds in India using
‘relative performance indices’, ‘Treynor’s and Sharpe’s ratios’, ‘risk-return
analysis’, ‘Jensen’s measure’, and ‘Fama’s measure’, and concluded that most of
the mutual funds had given positive returns during the period of study. Jain
(2012) investigated the performance of equity mutual funds in India using
‘CAPM’. The results show that, in the long run, the performance of private
sector companies’ MFs have been far better than the public sector ones. Out of
the pool of sample companies, HDFC and ICICI were the best performers whereas
LIC did not perform well. Thus, the overall analysis discovered that the private
sector mutual fund schemes were less risky but more rewarding when compared to
the public sector ones. M.S. Annapoorna and P.K. Gupta (2013) assessed the
mutual fund schemes performances which had been ranked ‘1’ by CRISIL and
compare these returns with SBI’s domestic term deposit rates. For the purposes
of calculation, simple statistical methods of ‘averages’ and ‘rate of returns’
were used. The results obtained clearly depicted that, in most cases, the mutual
fund schemes have been unsuccessful in providing benefits akin to the SBI
domestic term deposits.

Dr.R. Karrupasamy and V. Vanaja (2013) studied
and evaluated the performance of large-cap, mid-cap and small-cap equity mutual
funds on a risk-adjusted basis, using ‘Sharpe’s’, ‘Jensen’s’ and ‘Treynor’s’
measures, for a period of three years. The findings suggested that most of the selected
schemes had outperformed the category average as well as the benchmark indices.
They also proposed that investors looking for an investment below 2 years could
go for large-cap schemes, whereas those having investment beyond 3 years should
invest in small and mid-cap schemes.

A.C. Bhavsar, Akshay Damani and Anvesha (2014)
contributed by giving a comparative exploration of the performance of select
private and public sector mutual funds, in their study “A Comparative Study of
the Performance of Selected Mutual Fund Growth Schemes from the Private Sector
and Public Sector Schemes in India”, concluding that mutual funds with public
sector holdings had been greater performers when compared to their private
sector complements. Also, with ‘Jensen’s alpha’, private sector funds had been
ranked better, but a higher rank was given to public sector funds under the ‘Treynor’
and ‘Sharpe’ ratios. Kavita Arora (2015) studied the risk- adjusted performance
of 100 mutual funds from the period April 1, 2000 to March 31, 2008, where the
results for overall performance was mixed: ‘Sharpe’s ratios’ of 52 mutual fund
schemes were better than that their benchmark indices; and, ‘Treynor ratios’ of
70 per cent of mutual fund schemes were higher than their respective indices.
Thus, almost half of the mutual funds have performed better than their indices,
in a broader perspective.