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Performance of the Indian mutual funds: a study with special reference to growth schemes.

Introduction

Globalization, economic liberalization and financial sector reforms generated and augmented the interest of Indian investors in equity. With the growing institutionalization, retail investors have started to keep out of the primary and secondary market, and are looking forward to mutual funds for their investments. Mutual funds have become the most favored investment route for small and medium investors to reap the benefits of diversification even with a meager amount of investment in the capital market in an indirect route. Out of the 32 crore employed Indians, only 2.5% are investors. Many investors, particularly youth, having dispensable income opt for mutual funds to enter into the securities market indirectly. Hence, potential investors in mutual funds need evaluation not only by financial institutions but also by academicians so that they can make a right choice in their investment decisions. To meet the needs of the potential investors, many studies have been carried out. The following are the noteworthy studies carried out by academicians contributing towards the all round development of the mutual fund industry. The research work by Friend, et al., (1962), Sharpe (1966), Treynor and Mazuy (1966), Jensen (1968), and Tito (1969) and Fama (1972) contributed for the development of the theoretical modeling and in framing the methodology for the quantitative evaluation of mutual funds with risk-return as parameters. Based on the methodology developed by the above authors, Friend, Blume and Crockett (1970) identified the relationship between performance and turnover. Carlson's (1970) analysis brought out relationship between cash inflows into funds and consistency between risk and return. Williamson (1972) & Klemosky (1977) identified correlation and consistency between the rankings of adjacent two periods. Klemosky (1973) introduced mean absolute deviation and semi-standard deviation as risk surrogates compared to the composite measures derived from the CAPM to remove bias in Sharpe, Treynor, and Jensen's measures. John and McDonald (1974) identified that more aggressive funds experience better results due to the relationship between objective and risk-adjusted performance. Gupta (1974) found out that, return per unit of risk varied with the level of volatility assumed, and funds with higher volatility exhibited superior performance. Meyer's (1977) findings based on stochastic dominance model, revalidated Sharpe's findings. Rich Fortin, Stuart Michelson (1995) identified that lower expense ratio existed in no-load funds and suggested their suitability for six year holding while load funds were suitable for fifteen year holding. Wilfred L Dellva and Gerard T Olson (1998) observed that, informational competence of funds increased the efficiency in operation, reduced expenses besides providing higher risk-adjusted returns. Vidhyashankar S (1990) & Bansal L K (1991) opined that Indian mutual funds would become one of the predominant instruments of investment due to the benefits of liquidity, safety, reasonable appreciation, better control and accountability ensured through a set of guidelines by Association of Mutual Funds of India(AMFI), Securities and Exchange Bureau of India(SEBI) and Government of India. Sarkar A K (1991) pointed out that Sharpe and Treynor performance measures ranked mutual funds alike even with different risk levels and suggested the usage of Treynor measure to compare individual assets with portfolios.

As the concept of mutual fund is gaining more and more importance with a wide array of institutions vying to lure the investing public, a proper evaluation of performance of mutual funds, ability of the funds to diversify and time their investment is of practical importance for a valued judgment. In India, mutual funds are offering a variety of schemes based on objective to suit the needs of varied class of investors, namely, income, growth, balanced, equity linked savings, gilt, money market. Among the varied schemes of mutual funds, equity oriented schemes are expected to gain more momentum in future in the background of buoyant and stable stock market and the kind of tax relief granted. Growth oriented mutual funds are expected to offer the advantages of diversification, market timing and selectivity besides capital appreciation for its unit-holders. The potential investors find it difficult to make investment decision in the present scenario of multitudinous mutual fund schemes. Risk-return analysis of schemes can provide information on their performance in addition can help the investors to judge the fund managers' ability in selecting shares and timing of security transactions. Hence, this article intends to study the mutual fund growth schemes with growth options launched in the year 1993 and continue to be in operation under the regulated environment with the following objectives:

(i) To study the performance of growth schemes in relation to market.

(ii) To identify the consistency in performance of selected growth schemes.

Methodology

The secondary data was collected from the records of AMFI, UTI Institute of Capital Markets, and web sites of respective mutual funds. Performance evaluation is restricted to the schemes launched in the year 1993 when the industry was thrown open to private sector under the regulated environment by passing the SEBI (Mutual Funds) Regulations 1993. For the present study, the sampling frame included all the 25 schemes launched in the year 1993 in the Indian Mutual Fund Industry. On the basis of type of scheme, two were open-end and 23 were close-end. From the objective point of view, 10 were growth schemes, eight were tax savings schemes, four were balanced schemes and three were income schemes. Since 92% were close-end and 40% were growth schemes, a detailed in-depth study of seven growth schemes in operation was selected. Seven short listed schemes were initially close-end and latter converted into open-end on various dates. Thus the sampling frame for the purpose of the study constitutes the following schemes:

(i) SBI Magnum Multiplier Plus 1993

(ii) LIC MF Equity Fund [LIC Dhanvikas(1)]

(iii) Cangrowth Plus [GIC Growth Plus II]

(iv) UTI Opportunities Fund [UTI Grandmaster 93]

(v) Franklin India Blue Chip Fund [Kothari Pioneer Blue Chip Fund]

(vi) Franklin India Prima Fund [Kothari Pioneer Prima Fund]

(vii) HDFC Capital Builder Fund [Zurich India Capital Builder Fund]

Scheme names within square brackets indicate their former name. Performance in terms of net asset value (NAV) of growth schemes with growth option alone was studied from the angle of risk and return in comparison to the benchmark (BSE 100) index from April 1998 to March 2006. The study does not take into consideration the impact of brokerage, commission, entry load, exit load and taxes.

Tools and Techniques of Analysis

The tools like rate of return, risk, risk-free rate of return were used for risk-return analysis of schemes with reference to market. The analysis tools adopted in this article were previously adopted by Yadav R A (1996), Biswadeep Mishra (1996), Sarkar A K (1991), Jayadev M (1996), Shashikant Uma (1993) and others, over a period of time. The collected information was analysed using simple and sophisticated techniques such as Pearson's Correlation, Auto correlation, Rank correlation, Coefficient of Determination, Kendall's Coefficient of Concordance and Z test. The measures developed on the assumptions of 'The Capital Asset Pricing Model' introduced and tested by Treynor (1965), Sharpe (1966), Jensen (1968) and Fama's Decomposition of Returns (1972) were used to evaluate the performance of selected growth schemes. Sharpe's Index (St) measures the risk premium of the portfolio in relation to the total amount of risk. St is the reward to variability of the scheme's total risk and is a summary measure of scheme's performance adjusted for risk.

[S.sub.t] = [AR.sub.pt] - [R.sub.f]/[[sigma].sub.pt] (1)

Where [AR.sub.pt] refers to the average yield for a year calculated on the basis of changes in the weekly net assets value. [R.sub.f] is the risk-free rate of return. Reserve Bank of India bank rate of 6.00 percent is related with the most common preferred investment avenue namely bank deposits and so was adopted as risk-free rate of return. [[sigma].sub.pt] is the variability in return consisting of diversifiable risk and non-diversifiable risk. Treynor's Index ([T.sub.n]) measure is a reward to volatility of the portfolio.

[T.sub.t] = [AR.sub.pt] - [R.sub.f]/[beta] (2)

Where [beta] is the beta coefficient from the Characteristic Regression Line measuring the systematic risk of an asset reflecting volatility in portfolio return in response to market swings from the following formula:

[R.sub.i] = [[alpha].sub.1] [beta][R.sub.m] + [e.sub.1] (3)

Jensen's Alpha is the difference between the actual return from a portfolio and that of Equilibrium Average Return ([EAR.sub.p]). [EAR.sub.p] is the return of the portfolio for a given systematic risk calculated as follows:

[EAR.sub.p] = [R.sub.f] + b ([R.sub.m] - [R.sub.f]) (4)

Eugene Fama's Decomposition of Total Return provides for a detailed breakdown of fund performance as follows:

Return from Systematic Risk

= [[beta].sub.p] ([R.sub.m] - [R.sub.f])

Return from Unsystematic Risk

= [([[sigma].sub.p] / [[sigma].sub.m]) - [[beta].sub.p]] * ([R.sub.m] - [R.sub.f])

Fama's net selectivity

= [R.sub.p] - [[R.sub.f] + ([[sigma].sub.p] / [[sigma].sub.m]) * ([R.sub.m] - [R.sub.f])]

Sharpe's Differential Return measures the ability of the fund manager in security selection and in diversifying portfolio. If a portfolio is well diversified, Jensen and Sharpe measure indicates the same quantum of differential return. Sharpe's Differential return measures the incremental returns earned by the mutual fund manager for a given level of total risk using the formula:

= [R.sub.i] - ([R.sub.f] + ([R.sub.m] - [R.sub.f]) [[sigma].sub.i] / [[sigma].sub.m])

Results and Discussion

The risk-return performance of sample schemes during the eight years of study revealed the following:

* All the seven schemes covered under the study showed negative risk premium, Sharpe index and Treynor index in all the years covered under

the study indicated that, the return of the schemes' was insufficient to cover the risk undertaken by the investors.

* Modified Sharpe index (less than one) for SBI Magnum Multiplier Plus scheme shows that the scheme under-performed the market in all the years covered under the study compared to other sample schemes, which out-performed the market in some years.

* The positive beta values for all the sample schemes throughout the period of study revealed that the performance of the schemes and that of the market were in same direction. However, the beta values of LIC MF Equity Scheme, Cangrowth Plus Scheme, Franklin India Bluechip Scheme, and Franklin India Prima Scheme being less than one in all the years indicated their defensive nature compared to the market.

* Modified Treynor index was less than one in the case of Franklin India Prima Scheme revealing that the scheme did not out-perform the market in all the years under the study as against out-performances by other sample schemes. SBI Magnum Multiplier Plus Scheme showed positive Jensen's Alpha in many years covered under the study.

* An overall analysis of the sample schemes during the study period revealed that, the return from Franklin India Prima Scheme (0.0086) was the highest among the seven schemes. The risk of LIC MF Equity Scheme was the lowest (0.0380). The beta value was the lowest for HDFC Capital Builder Scheme (0.5605) and the highest in the case of SBI Magnum Multiplier plus scheme (1.1121).

* SBI Magnum Multiplier Plus scheme (-0.6033) and Cangrowth Plus scheme (-0.9508) topped the list based on Sharpe Index. SBI Magnum Multiplier Plus scheme (-0.0481) and UTI Opportunities scheme (-0.0643) topped the list based on Treynor Index. Only SBI Magnum Multiplier Plus Scheme (0.0089) provided positive Jensen's alpha indicating its superior performance compared to expectations.

* Eugene Fama's Decomposition of total return reported negative values of return on systematic as well as unsystematic risk implying that the market return was less than the risk-free return during the period of study. The return on systematic risk was the lowest in the case of HDFC Capital Builder Scheme (-0.0315) and the highest in the case of SBI Magnum Multiplier Plus scheme (-0.0624). The return on unsystematic risk was the lowest in the case of LIC MF Equity Scheme (-0.0079) and the highest in the case of HDFC Capital Builder Scheme (0.0835). The positive return from stock selectivity implied that all the sample schemes (except LIC MF Equity scheme) had superior return. SBI Mangum Multiplier Plus scheme provided the highest net superior returns due to selectivity skills assuming higher risk.

* An analysis of the scheme's risk in comparison with benchmark index revealed that, SBI Magnum Multiplier Plus Scheme showed high explained (0.0023) and high unexplained (0.0056) variance. HDFC Capital Builder Scheme (0.0006) showed low explained variance and LIC MF Equity Scheme (0.0004) showed low unexplained variance in comparison to market index.

* The interactive risk between the market and the scheme's returns were positive for all the schemes covered under the study. SBI Magnum Multiplier Plus Scheme (0.0020) showed the highest interactive risk while HDFC Capital Builder Scheme (0.0010) showed the lowest interactive risk.

* The market return had a significant impact on all the sample scheme's returns, as the calculated Z Value was greater than the table value as shown in Table 1.

* The results of the autocorrelation as depicted in Table 2 shows that, the present NAV is positively and significantly correlated with the past NAV for all the time lags of all the sample schemes studied. Thus, there exists a high degree of positive correlation in weekly time lag and the impact gets reduced as the time lag increases.

* The relationship between Treynor and Jensen was the highest (0.8929) and the relationship was the lowest (0.6429) between Sharpe and Treynor's measures of performance evaluation as shown in the Table 3. The Kendalls Coefficient of Concordance with a calculated value of 's' (220) greater than the table value (157.3) is significant at 'w' (0.8730). Hence, it can be inferred that, there is a significant agreement in ranking as per the three (Sharpe, Treynor and Jensen) measures. All the three measures on the whole, assigned first rank to SBI Magnum Multiplier Plus scheme in terms of performance compared to market and risk elements.

Conclusion

The hallmark of any mutual fund is to out-perform the market both in rising and falling conditions, besides ensuring benefits of diversification. During the eight years of study period, the sample schemes outperformed the market in terms of absolute returns. The performance of the sample schemes were in line with that of the market as evident from the positive beta values. All the sample schemes were not well diversified as depicted by the differences in the Jensen alpha and Sharpe's Differential return. All the three risk-adjusted performance measures (Sharpe, Treynor and Jensen Models) depicted poor performance of the sample schemes and also ensured significant agreement in their ranking as reflected in many of the earlier studies. The sample schemes did not provide adequate return in terms of systematic risk and unsystematic risk. However, the sample schemes ensured positive returns due to stock selection skills of fund managers. The market performance had a significant positive influence on the entire sample schemes' performance. The present net asset value of all the sample schemes are positively and significantly correlated with its past net asset value for all the time lags signifying consistency in successive period returns.

References

Bansal L K (1991), "Challenges For Mutual Funds In India", Chartered Secretary, Vol. 21 (10), pp. 825-26.

Carlson Robert S (1970), "Aggregate Performance of Mutual Funds, 1948-1967", Journal of Financial and Quantitative Analysis, Vol. 5, pp. 1-32.

Fama F Eugene (1972), "Positive Components Of Investment Performance", Journal of Finance, Vol. 27, pp. 551-567.

Friend I, Brown F, Herman E and Vickers D (1962), "A Study of Mutual Funds" U.S. Securities and Exchange Commission.

Friend Irwin, Blume Marshall and Crockett Jean (1970), "Mutual Funds and Other Institutional Investors; A New Perspective", McGraw Hill Book Company, New York.

Gupta Manak C (1974), "The Mutual Fund Industry and its Comparative Performance", Journal of Financial and Quantitative Analysis, Vol. 6, pp. 894.

Jayadev M (1996), "Mutual Fund Performance: An Analysis of Monthly Returns", Finance India, Vol. 10 (1), pp. 73-84.

Jensen Michael C (1968), "The Performance of Mutual Funds in the Period 1945-1964", Journal of Finance, Vol. 23, pp. 389-416.

John G and McDonald (1974), "Objectives And Performance Of Mutual Funds, 1960-69", Journal of Financial and Quantitative Analysis, Vol. 9, pp. 311-333.

Klemosky Robert C (1973), "The Bias in Composite Performance Measures", Journal of Financial and Quantitative Analysis, Vol. 8, pp. 505-514.

Klemosky and Robert C (1977), "How Consistently Do Managers Manage", Journal of Portfolio Management, Vol. 3, pp. 11-15.

Meyer Jack (1977), "Further Applications of Stochastic Dominance to Mutual Fund Performance", Journal of Financial and Quantitative Analysis, Vol. 12, pp. 917-924.

Rich Fortin, Stuart Michelson (1995), "Are Loads Mutual Funds Worth The Price?" Journal of Investing, Vol. 4(3), pp. 89-94.

Sarkar A K (1991), "Mutual Funds In India Emerging Trends", Management Accountant, Vol. 26(3), pp. 171194.

Sharpe F William (1966), "Mutual Fund Performance", The Journal of Business, Vol. 39 (1), pp. 119-138.

Shashikant, Uma (1993), "Accounting Policy and Practices of Mutual Funds: The Need for Standardization", Prajan, Vol. 24 (2), pp. 91-102.

Smith V Keith and Tito Dennis A (1969), "Risk-Return Measures of Post-Portfolio Performance" Journal of Financial and Quantitative Analysis, Vol. 4, pp. 449-471.

Treynor Jack L (1965), "How to Rate Management of Investment Funds", Harvard Business Review, Vol. 43(1), pp. 63-75.

Treynor, Jack L and Mazuy Kay K (1966), "Can Mutual Funds Outguess The Markets" Harvard Business Review, Vol. 44, pp. 131-136.

Vidhyashankar S (1990), "Mutual Funds: Emerging Trends in India", Chartered Secretary, Vol. 20 (8), pp. 639-640.

Williamson, Peter J. (1972), "Measurement and Forecasting of Mutual Fund Performance: Choosing an Investment Strategy", Financial Analysts Journal, Vol. 28, pp. 78-84.

Wilfred L.Dellva, Gerard T. Olson (1998), "The Relationship between Mutual Fund Fees and Expenses and Their Effects on Performance", The Financial Review, Vol. 33 (1), pp. 85-104.

Yadav R A and Biswadeep Mishra (1996), "Investment Pattern of household sector in financial assets: An empirical investigation", MDI Management Journal, Vol. 9 (1), pp. 65-75.

N. Lakshmi *, Malabika Deo ** and B. Murugesan *

* Sri G.V.G. Visalakshi College for Women, Udumalpet--642 128, Tamil Nadu, India.

** School of Management, Pondicherry University, Pondicherry--605014, India

* E-mail: natarajan.lakshmi@rediffmail.com, ** E-mail: deo_malavika@yahoo.co.in
Table 1: Impact of Market on the Performance of Sample Schemes

 Calculated
Mutual Fund Scheme Covariance Correlation Z Value

Cangrowth Plus Scheme 0.0014 0.5584 13.70 *

Franklin India Bluechip Scheme 0.0015 0.7400 22.39 *

Franklin India Prima Scheme 0.0014 0.6330 16.64 *

HDFC Capital Builder Scheme 0.0010 0.5379 12.98 *

LIC MF Equity Scheme 0.0014 0.8430 31.89 *

SBI Magnum Multiplier Plus
Scheme 0.0020 0.5342 12.86 *

UTI Opportunities Scheme 0.0016 0.7504 23.10 *

* Significant at five percent level.

Table 2: Autocorrelation of Net Assets Value of Sample Schemes

 Time Lag
Mutual Fund Scheme
 Weekly Monthly Quarterly

Cangrowth Plus Scheme 0.9751 0.914 0.7595
 (89.48) * (45.85) * (23.75) *

Franklin India Bluechip 0.9809 0.9231 0.7741
Scheme (102.62) * (48.83) * (24.88) *

Franklin India Prima Scheme 0.9871 0.9487 0.8376
 (125.08) * (61.05) * (31.20) *

HDFC Capital Builder Scheme 0.9852 0.9421 0.8277
 (117.07) * (57.14) * (30.01) *

LIC MF Equity Scheme 0.9818 0.9299 0.7958
 (105.28) * (51.46) * (26.74) *

SBI Magnum Multiplier Plus 0.9743 0.9061 0.7023
Scheme (87.95) * (43.57) * (20.07) *

UTI Opportunities Scheme 0.9771 0.9073 0.7064
 (93.38) * (43.90) * (20.31) *

 Time Lag
Mutual Fund Scheme
 Half Yearly Yearly

Cangrowth Plus Scheme 0.5685 0.2035
 (14.06) * (4.23) *

Franklin India Bluechip 0.6074 0.3735
Scheme (15.56) * (8.19) *

Franklin India Prima Scheme 0.6922 0.4528
 (19.52) * (10.33) *

HDFC Capital Builder Scheme 0.6751 0.4209
 (18.62) * (9.44) *

LIC MF Equity Scheme 0.6463 0.3687
 (17.24) * (8.07) *

SBI Magnum Multiplier Plus 0.486 0.1137
Scheme (11.31) * (2.33) *

UTI Opportunities Scheme 0.4583 0.1975
 (10.49) * (4.10) *

* Significant at five percent level.

Table 3: Comparison of Performance Evaluation Models

 Sharpe Treynor
Mutual Fund Scheme
 Index Rank Index Rank

Cangrowth Plus Scheme (-) 0.9508 II (-) 0.0726 V

Franklin India Bluechip Scheme (-) 1.1392 V (-) 0.0656 IV

Franklin India Prima Scheme (-) 0.9576 III (-) 0.0645 III

HDFC Capital Builder Scheme (-) 1.2169 VI (-) 0.0964 VII

LIC MF Equity Scheme (-) 1.5057 VII (-) 0.0761 VI

SBI Magnum Multiplier (-) 0.6033 I (-) 0.0481 I
Plus Scheme

UTI Opportunities Scheme (-) 1.1317 IV (-) 0.0643 II

 Jensen Alpha
Mutual Fund Scheme
 Index Rank

Cangrowth Plus Scheme (-) 0.0125 V

Franklin India Bluechip Scheme (-) 0.0078 IV

Franklin India Prima Scheme (-) 0.0066 II

HDFC Capital Builder Scheme (-) 0.0226 VII

LIC MF Equity Scheme (-) 0.0150 VI

SBI Magnum Multiplier 0.0089 I
Plus Scheme

UTI Opportunities Scheme (-) 0.0073 III

Spearman's Coefficient of Correlation:

Ranking between Sharpe and Treynor's Measure = 0.6429

Ranking between Treynor and Jensen's Measure = 0.8929

Ranking between Sharpe and Jensen's Measure = 0.7500
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Author:Lakshmi, N.; Deo, Malabika; Murugesan, B.
Publication:Asia-Pacific Business Review
Date:Jul 1, 2008
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