The Performance of Mutual Funds Managers in Asia Pacific: Skill or Luck?

2013

The Performance of Mutual Funds Managers in Asia Pacific: Skill or Luck?

1. Aim and Motivation
The most frequent question launched by a mutual fund investor perhaps is how the fund performs over time, whether it can persistently generate positive risk-adjusted returns. This topic has been intensively researched because of its importance to consider before investing in any fund or to evaluate whether a particular fund meets investors financial goals, at least since Jensen (1968) evaluated the mutual funds performance for the period 1945 1964 and he did not find any evidence of mutual fund manager skill. Unfortunately, despite the fact that so many researchers did deep researches in this area, especially in US market, with different methods and different time periods, there is still no exact conclusive answer regarding the real skill of mutual fund managers. More importantly, knowing the fact that mutual fund investors have to pay extra money for mutual fund fees for the services provided by the fund, that is considerably not a small percentage, ranging from average of 2 to 4 per cent, it is very important to take account this cost to the performance evaluation. It is because even though the mutual funds might generate positive returns, but the net returns (including fees) might be negative. However, many past studies before 1990s did not explicitly concern and model the role of luck in performance evaluation. Therefore, some literatures tried to account this luck factor through measuring out-of-sample performance to control for luck or the use of bootstrapping method for both outperform and underperform funds that might reveal the true performance of mutual fund managers, whether it is a real superior stock-picking skill or merely luck. In accordance with the promising and growing population of mutual funds in Asia Pacific countries, the writer would like to emphasize on this market to be analyzed further. Despite Asia accounts for approximately 60% of the worlds population, Asian investors investments only account for 13% of the mutual fund industry, compared to 52% in the America and 35% in Europe, according to PwC research (Figure 1). Looking at the past
Dissertation Proposal for MSc Financial Analysis and Fund Management Allan Tandhyka Gemiarto (620034757)

The Performance of Mutual Funds Managers in Asia Pacific: Skill or Luck?

2013

growth and the global economy dominance in the last few years in Asia Pacific countries, it is very probable that more significant development will be shown in the near future. Therefore, the writer feels the urge to analyze this topic in Asia Pacific countries, so Singapore and Australia are chosen to represent developed countries within Asia-Pacific region, while Indonesia and Thailand to represent the emerging countries.

Source: PwC Research Figure 1. Mutual Funds in Asia Pacific countries Therefore in this paper, the writer would like to address three questions to answer. Firstly, whether the open-end mutual funds in Indonesia, Thailand, Singapore, and Australia can outperform the benchmark. Secondly, by taking the commercial fees into consideration, whether those funds are able to bring positive return to investors. Last but not least, the writer would like to know the reason behind if the mutual funds cannot beat the market and/or not able to generate profit. However, if yes, is it due to fund managers skill or merely luck.

Dissertation Proposal for MSc Financial Analysis and Fund Management Allan Tandhyka Gemiarto (620034757)

The Performance of Mutual Funds Managers in Asia Pacific: Skill or Luck?

2013

2. Literature Review

Dissertation Proposal for MSc Financial Analysis and Fund Management Allan Tandhyka Gemiarto (620034757)

The Performance of Mutual Funds Managers in Asia Pacific: Skill or Luck?

2013

3. Methodology
3.1. Mutual Fund Performance Following the mutual fund literatures, this papers approach to analyze the performance of mutual funds is by using some factor models with time-series Ordinary Least Squared regressions, i.e. Jensens Alpha and Carhart Four-Factor Model.

3.1.1 Jensens Alpha A traditional approach of measuring performance is to regress the excess return of a portfolio on the market factor, known as Jensens Alpha. It is a risk-adjusted measure of
Dissertation Proposal for MSc Financial Analysis and Fund Management Allan Tandhyka Gemiarto (620034757) 4

The Performance of Mutual Funds Managers in Asia Pacific: Skill or Luck?

2013

portfolio performance, which based on the theory of the pricing of capital assets by Sharpe (1964), that estimates how much a manager's forecasting ability contributes to the fund's returns. Assuming that the market beta ( is constant and the unconditional alpha ( ) is a

measure of funds average performance, the formula is given by: ( where error term. With the given formula, the writer is able to estimate the alpha for individual mutual funds and then calculate the benchmark-adjusted returns by simply subtracting the return of the benchmark from the monthly returns. However, there are some limitations to Jensens Alpha. First, since it only considers one factor in the model, investors might end up investing in small stocks that tend to be more risky, rather than investing in large market-cap stocks. Second, in practice, beta is not constant, because when mutual fund manager changes the portfolio composition, the beta will also change. Therefore, the writer comes up with different method, namely four-factor model by Carhart (1997). and ( ) [1] is an

) are the fund and market net return minus T-bills, while

3.1.2 Carhart Four-Factor Model The Carhart model is the extension of the Fama and French (1993) three-factor model and is effectively a four-factor Jensen measure. This model assumes that betas with respect to the returns of four zero-investment factor-mimicking portfolios that are the appropriate measures of multidimensional systematic risk. Those factors are: 1. Month t excess return on a value-weighted aggregate market proxy portfolio (RMRF) 2. Small size minus big size (SMB) 3. High book-to-market minus low book-to-market (HML) 4. High prior-year return less low prior-year return (PR1YR)

Dissertation Proposal for MSc Financial Analysis and Fund Management Allan Tandhyka Gemiarto (620034757)

The Performance of Mutual Funds Managers in Asia Pacific: Skill or Luck?

2013

This model implies that in the absence of stock-selection or timing abilities, the expected return for a fund is simply the expected returns of each of these four zeroinvestment portfolios. Alpha j ( the following regression: [2] , which is the Carhart measure for fund j, is estimated with

where minus T-bills)

equals the excess net return of fund j during month t (the fund net return

The important factor in this model is the momentum effect, represented by PR1YR, which is defined as the effect of buying stocks that were past winners and selling past losers stock (Grinblatt, Titman, and Wermers, 1995). This might be done by ranking the mutual funds based on average monthly returns for one-calendar year prior to portfolio formation, and form groups from it. Normally, the bottom 20% is referred to losers portfolio, while top 20% is referred to past winners, similar with research done by Ahmad and Samajpati (2010).

3.2 Test of Significance of Alpha () After the alpha has been derived from previous models, the writer would like to run a further significance test on alpha using two-sided t-test. Here, the null hypothesis is that mutual funds excess return is zero, which means that both mutual fund and benchmark have the same performance (H0: =0). On the other hand, the alternate hypothesis is that mutualfunds excess return is positive (negative), which implies that mutual fund mana ger perform better (worse) than the benchmark (Ha: 0). . 3.3 Bootstrapping For funds with positive alpha, it is possible that the estimated alphas are positively high due to luck factor. Therefore, a bootstrap method will be conducted in order to reveal whether it is due to manager s superior stock-picking skill or just simply lucky. The logic behind this is that the cross section of mutual fund alphas has a complex nonnormal distribution due to heterogeneous risk-taking by funds as well as nonnormalities in individual fund alpha distributions (Kosowski et al., 2006).
Dissertation Proposal for MSc Financial Analysis and Fund Management Allan Tandhyka Gemiarto (620034757) 6

The Performance of Mutual Funds Managers in Asia Pacific: Skill or Luck?

2013

Specifically, Kosowski et al. simulated the bootstrap by first calculating the estimated , its t-statistic, and calculating the value of the cross-sectional t() distribution at each percentile. Secondly, they subtracted the estimated actual from its returns to generate a return series with a true of zero . Thirdly, they randomly drew weeks to generate new return series per simulation run and then estimated a new simulated and t() per portfolio in each simulation run. Last but not least, they computed the t() value at each percentile as an average of the percentile values from all simulation runs.

Data Description
With the first objective to analyze the performance of mutual funds, monthly data

regarding the last prices are gathered and then will be manually calculated to generate the monthly return. The dataset was derived from Bloomberg, specifically from 1990 to February 2013, reflecting 22 years of data. Due to the problem of survivorship bias, this dataset tries to eliminate it by covering all currently active as well as inactive funds for which a full set of last prices were available from inception of each fund until the current period. This survivorship-bias free dataset, which includes all share classes and all fund objectives, contains 429,881 funds and only 166,269 funds are classified under equity asset class, which is the appropriate data for this research. Furthermore, some limitations are set up to narrow down the dataset. The first limitation concerns about the country of availability of the mutual fund. As mentioned previously, this paper would like to emphasize on the mutual fund performance in growing Asia Pacific countries, thus, the dataset is narrowed down based on the four mentioned countries, i.e. Singapore, Australia, Indonesia, and Thailand. The second limitation is taking into account the fund style. Despite many ways to categorize mutual fund style types, this paper is trying to be consistent with the data source, Bloomberg. It classifies mutual fund through returns based style analysis, with three possible returns, which are 'Growth', 'Value', and 'Blend'. In brief, growth fund managers tend to use consistent growth and earning momentums strategy; value fund managers use low P/E, contrarian, and yield strategy; while blend fund managers use a mix of both strategies.

Dissertation Proposal for MSc Financial Analysis and Fund Management Allan Tandhyka Gemiarto (620034757)

The Performance of Mutual Funds Managers in Asia Pacific: Skill or Luck?

2013

Having set these limitations, the narrower dataset can be derived, shown in table 1 below. From this dataset, 2000 mutual funds will be used as the samples to represent the population. Table 1. Details of Number of Mutual Funds No Country of Availability 1 2 3 4 Singapore Australia Indonesia Thailand Number of Funds 8459 7563 951 2531 Number of Mutual Funds 1335 2585 906 2220 Value 147 731 22 74 Equity Type Focus Blend 314 629 77 199 Growth 113 82 145 28

Source: Bloomberg Moreover, to answer the first question on whether the open-end mutual funds in Indonesia, Malaysia, Singapore, and Australia are able to beat the benchmark, it is crucial to select the right benchmark in every country. Since the dataset represents only equity type fund, it is appropriate to use stock market index as the benchmark. Furthermore, the benchmarks chosen covers all the stock exchange listed in the market, because this paper narrows down the data based on equity type, without concerning the market capitalisation or size. For example, instead of using Strait Times Index (FSSTI:IND) that consist only the top 30 SGX Mainboard listed companies on the Singapore Exchange based on full market capitalization, this paper uses FTSE Strait Times All-Share Index (FSTAS:IND) which comprises all the top 98 per cent companies in SGX Mainboard universe by full market capitalization, combining large-cap, mid-cap and small-cap indices. Details are shown in Table 2 below. Table 2. Proposed Benchmark No Country Proposed Benchmark (Bloomberg Ticker) 1 Singapore FTSE STRAIT TIMES ALL SHARE INDEX (FSTAS:IND) 2 Australia
a. AUSTRALIAN STOCK

Base Date

Last Available Date

5 October 2007 (revamped) 1979

Current

2002

EXCHANGE ALL ORDINARIES INDEX (AS30:IND)

Dissertation Proposal for MSc Financial Analysis and Fund Management Allan Tandhyka Gemiarto (620034757) 8

The Performance of Mutual Funds Managers in Asia Pacific: Skill or Luck? b. S&P/ASX300 (AS52:IND)

2013

April 2000 August 10, 1982

Current Current

Indonesia

JAKARTA STOCK EXCHANGE COMPOSITE INDEX (JCI:IND)

Thailand

STOCK EXCHANGE OF THAILAND SET INDEX (SET:IND)

April 30, 1975

Current

Source: Bloomberg

Structure of the Paper

The proposed structure of this paper is as follow: Chapter 1: Introduction Chapter 2: Literature review 2.1 Mutual Fund Performance 2.2 Bootstrapping Chapter 3: Methodology 3.1 Mutual Fund Performance Evaluation Methods 3.1.1 Jensens Alpha 3.1.2 Carhart Model 3.2 Test of Significance 3.3 Bootstrapping Chapter 4: Data Description 4.1. Description of Variables Chapter 5: Empirical results 5.1 Answer to question 1: Can open-end mutual funds in Indonesia, Thailand, Singapore, and Australia outperform their benchmarks? 5.2 Answer to question 2: After taking mutual fund fees into account, are open-end mutual funds in Indonesia, Thailand, Singapore, and Australia still able to generate positive return to their investors? 5.3 Answer to question 3: If not, why is it happened? If yes, is it due to mutual fund managers skill or merely luck ? Chapter 6: Conclusions, limitations, and recommendations for further researches

Dissertation Proposal for MSc Financial Analysis and Fund Management Allan Tandhyka Gemiarto (620034757)

The Performance of Mutual Funds Managers in Asia Pacific: Skill or Luck?

2013

References

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Ross, S.A., 1976. The arbitrage theory of capital asset pricing. Journal of Economic Theory, 13 (3), 341360. Sharpe, W.F., 1964. Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk. Journal of Finance 19, 416-422. Treynor, J.L., 1965. How to rate management of investment funds. Harvard Business Review 43, 6375. Zeckhauser, Hendricks, D., Patel, J., Richard, 1993. Hot hands in mutual funds: Short-run persistence of relative performance 1974-1988. The Journal of Finance, 48(1), 93130.

Dissertation Proposal for MSc Financial Analysis and Fund Management Allan Tandhyka Gemiarto (620034757)

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