5 Zib Vol2 Issue4

ZENITH International Journal of Business Economics & Management Research
Vol.2 Issue 4, April 2012, ISSN 2249 8826

Online available at http://zenithresearch.org.in/

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DETERMINANTS OF MUTUAL FUND PERFORMANCE WITH
SPECIFIC REFERENCE TO EQUITY LINKED SAVINGS SCHEME
(ELSS TAX SAVER FUND) A BIBLIOGRAPHIC REVIEW

N. VENKATESH KUMAR*; DR. ASHWINI KUMAR BJ**

*Assistant Professor & Head of the Department,
Acharya Institute of Technology,
Bangalore - 560090.
**Professor & Head of the Department,
Department of MBA,
Nitte Meenakshi Institute of Technology,
Bangalore-560064.

ABSTRACT

Mutual fund is a prospective investment vehicle that caters to the requirement of all categories of
investors. Though the funds are customised financial offerings, in a larger perspective, investors
tend to rationalize their investment decision based on the funds performance. Fund performance
analysis and its determinants were widely analysed over a longer tenure at market level and fund
specific level. This bibliographic review has been carried to examine the market related attributes
and fund related attributes, which determines the performance of tax saver funds. An extensive
survey of literature has shown that most studies consider mutual funds as a whole rather than
focusing on the specific category of tax saver fund (kothari and warner, 2001). It is seen that past
works relating to mutual fund performance can be classified as researching the following:

a) General Studies to identify factors influencing fund performance

b) Individual factors influencing fund performance

c) Studies relating to specific category of funds

d) Methodological approaches in measuring fund performance

After examining research papers, studies were more focused on Equity, Bond and Balanced
funds to measure fund performance on risk-adjusted basis and no specific attempts were made to
understand the determinants of Tax Saver fund performance.

KEYWORDS: Bibliographic review, Determinants, Methodological Approach, Mutual Fund,
Tax Saver Fund.
______________________________________________________________________________


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INTRODUCTION
I. GENERAL STUDIES TO IDENTIFY FACTORS INFLUENCING MUTUAL FUND
PERFORMANCE
Treynor (1965) recognised that the major problem in evaluating the performance of portfolio
managers was in measuring the risk of portfolios. He emphasised that if the market is in
equilibrium, the ratio of excess mean return to the assets beta will be the same for all assets, and
will equal the excess mean rate of return on the market portfolio. In such conditions all well
diversified portfolios will move with market and portfolio yields high return when market
provides high returns vice-versa.
Sharpe (1966) aimed at explaining the Portfolio selection, Pricing of capital assets under
conditions of risk, general behaviour of stock market prices and its impact on mutual fund
performance. The model proposed to evaluate the performance of mutual funds was to determine
the Reward (Excess Return than the risk-free) for a unit of risk. His research clearly exhibits that
the relationship predicted by the theory of capital asset prices is clearly present and the funds
have larger aggregate return attached to larger variability than those with smaller average return.
Treynor and Mauzy (1966) examined the claims made by the fund managers that they can
anticipate major stock market movements. They devised a statistical test of mutual funds
historical success in anticipating major turns in the stock market. They argued that the only way
in which fund managers can translate ability to outguess the market into benefit to the investor is
by varying the fund volatility systematically in such a manner that the resulting characteristic
line is concave upwards. The study suggests that an investor in mutual funds is completely
dependent on fluctuations in the general market and the improvement in the rate of return can
only be due to the fund managers ability to identify the under priced securities, companies and
industries rather than to any ability to outguess the turns in the level of the market as a whole.
Jensen (1968) constructed a measure of absolute performance on a risk adjusted basis and
evolved a definite standard against which the performance of various funds could be measured.
This standard provides a basis to measure the portfolio managers predictive ability, i.e. his
ability to earn higher returns through prediction of security prices given the risk profile of the
portfolio. The study led to the conclusion that mutual funds on average were not able to predict
security prices well enough to outperform the market. Not even an individual fund was able to do
significantly better than that expected from a mere random chance.
Walter (1969) found that two broad styles of investing were emerging. Gunslingers are the
aggressive investors who feel that they can identify the change before the subdued investors and
capitalise on it. Their personality traits are young, arrogant, deals in concepts, not price earnings
ratios. Serious long term investors are basically interested in earning trend, concentrates on
areas of long term growth and fundamental work. They are less concept oriented and more
price-earnings ratio oriented.
Carlson and Robert (1970) observed that the question of whether or not funds outperform the
market is very much a function of both the time period used and the proxy selected to

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represent the market. They found that objectives of the fund were significantly related to its
risk and return.
Arditti (1971) emphasised on introducing a variable namely the third moment of the fund's
annual rate of return since the Sharpe's Reward to variability ratio proved that the funds did not
out perform Dow Jones Industrial average. He proved that although the fund managers do
poorly with Reward-to-Variability ratio, they can do well with respect to the skewness condition.
The implication is that fund managers are willing to give up some expected return or take on a
bit more variability in exchange for a greater chance at a large annual return.
Lease, Lewellen, and Schlarbaudes (1974) concluded that the prospective individual investor to
be primarily a fundamental analyst who perceives himself to hold a balanced and well diversified
portfolio of income and capital appreciation securities. They invest predominantly for long run,
and use one of the broad based market indices as the benchmark to judge personal investment
performance results. They supplement their direct securities purchase activities quite frequently
with ownership of mutual fund units.
Philip (1977) identified that proper definition and measurement of risk are the two basic
problems in understanding investment risk. Although risk is related to uncertainty of future
events and more risk implies more uncertainty and risk is a personal concept reflected by the
view point of a particular investor.
Sanyal (1982) enumerated rationalisation of the diversified portfolio both at the micro and at
macro levels, by referring to the fact of substantial indivisibility involved in the typical portfolio
choice problems. He argued in the context of a choice between financial assets (interest bearing
deposits) and physical assets, which available only in multiples of an indivisible minimum unit,
rather than in the context of the liquidity preference theory. The model proposed by the author
facilitated not only with asset diversification but also two rather curious results could be proved;
1) if r is lower than the aggregate level, it will induce more rather than less deposit formation as
a proportion of total saving, 2) if the inflation rate of the real asset price is higher, and provided
that saving is growing fast enough, then there will be more and not less deposit formation as a
proportion of aggregate of savings.
Mrkvicka (1991) described the motives of rational investor and concluded that the motivational
variables associated with an investment are liquidity, stability, strength, hedge against inflation,
mobility and less time and expenditure needed to manage the investment. He found that mutual
fund investment gives liquidity, stability, strength, mobility and low management cost, which
characterise an ideal investment.
Ippolito (1993) had literally reproduced the analysis carried out by Sharpe and Jensen. This was
to support whether the mutual funds underperformed common market Indexes. He witnessed a
statistically important number of funds with negative alphas. The earlier findings suggest that a
sizable number of funds are sufficiently successful to generate an average industry experience
that matches the returns available from index funds after deducting the expenses and adjusting
for risk.

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Edwin, Elton and Gruber (1996) examined predictability for Stock Mutual funds using risk
adjusted returns. They found that past performance was predictive of future risk-adjusted
performance. Applying modern portfolio theory techniques to the past data improves selection
and allows us to construct a portfolio of funds that significantly outperforms a rule based on past
rank alone. Consistent with past studies, the study also finds that expenses account for only a part
of the differences in performance across funds.
Evensky (1997) mainly focused on information flow towards investors and selection and
evaluation of fund managers. He suggested three core "P"s namely Philosophy, Process, and
People. He quoted that the fund manager should not change stripes as market cycles come and
go. If the fund manager does then the effort expended in the selection process will be worthless
and Asset management is critically important to the development of adequate resources for both
short term and long term goals.
Collins and Mack (1997) evaluated the optimal size of Assets under Management. They found
that the expenses tend to increase with the output of each three kinds of mutual funds i.e. Bond
Funds, Equity Funds and Money market funds. The average mutual fund can achieve significant
economies of scale by expanding assets under management.
Edelen (1999) attributed a statistically significant indirect cost in the form of a negative relation
between a fund's abnormal return and investor flows. He concluded that negative return
performance at open-ended mutual funds is attributable to the costs of liquidity -motivated
trading.
Lamba (1999) provided empirical evidence to the perception that the market reacts not only to
domestic factors but also to external influences. The VAR method had been used to analyse the
daily market returns for the period of 1994-98. The results indicated that the Indian market
appears to be quite isolated from external influences. Despite this, and with continuing market
reforms, it is likely that the Indian market will continue to provide a viable investment avenue to
foreign investors especially in the light of the continuing uncertainty among the emerging
markets in South-east Asia.
King Jr. (2002) examined investor orientations regarding their investment choices. He
enumerated the main advantages and disadvantages of Mutual funds and highlighted the other
channels of investments like Exchange traded Funds (ETF), Hedge Funds, Managed Accounts
and Portfolio Investment programs that offer greater tax benefits than mutual funds. The author
highlighted that the Managed accounts and Portfolio investment programs allow investors higher
flexibility and control over the specific investments held in their portfolio and also that the
mutual fund industry is reaching maturity. In addition, the lower (Negative) returns achieved by
many funds in the past perhaps cause investors to focus more on fund expenses, leading investors
to seek lower cost funds or other products with a lower cost structure than mutual funds.
Benartzi and Thaler (2002) stated that there is a worldwide trend towards defined contribution
savings plans, where investors are often able to select their own portfolios. They presented
retirement investors with information about the distribution of outcomes they could expect to
obtain from the portfolios they picked for themselves, and the same information for the median
portfolio selected by their peers. Majority of the survey respondents actually preferred the

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median portfolio to the one they picked for themselves. They concluded that investors do not
have well-defined preferences.
Mehta (2005) attempted to analyse ex-ante performance of the portfolios constructed using
Markowitz model in the Indian Security Market. He used Sharpe, Treynor, Fama measures to
compare the shares performance with market performance. He found that 53.7% of the portfolios
performances were superior than the market. But the performance of portfolios is not
significantly different from market proxy i.e. SENSEX at 10% level of significance.
Shanmugam and Muthuswamy (2005) attempted to describe the investment process of Indian
investors and accentuated that the investment public in India drawn from middle income group
investors are divided into three groups namely tax savers, traditionalists and risk takers. They
highlighted the differences in investors preference over various investment parameters and apart
from giving importance to regional industry in personal portfolio, occupation of investors was
found to be having an impact on investment decision.
Puttonen and Seppa (2007) analysed whether there were major differences in the behaviour of
the commonly used Dow Jones Stoxx and Morgan Stanley Capital International (MSCI)
European style indices. They concluded that the Dow Jones Stoxx and MSCI indices performed
equally to each other during the study period.
Eling (2008) attempted to analyse whether abnormal return can be sufficiently evaluated by
using Sharpe ratio or not. He found that the choice of performance measure does not affect the
ranking of hedge funds and mutual funds. This study exhibited a little negative relationship
between the rejection rate for the Jarque-Bera test and the rank correlation. He concluded that the
Sharpe ratio is adequate for analysing the returns of hedge funds and the returns of mutual funds.
Kozup, Howlett and Pagano (2008) explored whether a modified method of supplemental
information disclosure affects investors fund evaluation and investment intentions.
Khan (2010) had principal objective to measure and analyse the mutual fund performance by
using Reward to variability ratio, Reward to volatility ratio, Jensen and Fama's Net selectivity
models. The researcher found that as per the Sharpe model the funds were outperformed during
the study period with the ratio of 0.475 as compared to 0.33 of Benchmark. As per Treynor
model, the reward for volatility (Systematic risk) ratio of portfolio stood at 0.471 as compared to
0.18 pertains to benchmark. The predictive ability of the fund managers stood at 9% and it has
become apparent that their stock selection and market timing skills facilitated to generate
superior return than the market.
Srivastava (2010) studied the evidence supporting the existence of at least weak-form efficiency
of the market. The hypothesis of the study was whether the Indian Stock Markets are weak form
efficient. The study carried out in this paper has presented the evidence of the weak and efficient
forms of the Indian Stock Market.
Mehta and Chander (2010) designed to empirically test the three factor model suggested by
Fama and French on Indian stock market and to document the evidences as to how firm
characteristics are used as a better way to explain the stock return behavior. The overall findings

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indicated that the three factor model given by Fama and French is more powerful, than its other
variants of taking one or two factors in explaining the variability in the returns of all six
portfolios.
Jeyachitra, Selvam, and Gayathri (2010) attempted to analyze the portfolio performance of Nifty
stocks. The study found that there was a high positive correlation between portfolio returns and
risk. It also revealed that the portfolio unsystematic risk declined due to diversification. The
study was useful to understand the impact of systematic and unsystematic risk through portfolio
construction.
Rao and Daita (2010), narrated that investors can typically find Mutual Funds to suit their
investment outlook, tax planning, income needs, and risk preferences. In order that the Mutual
Funds derive their locus stand from their ability to diversify investments, one need to evaluate
the performance of Mutual Funds schemes before going to invest one's own funds.
II. INDIVIDUAL FACTORS INFLUENCING MUTUAL FUND PERFORMANCE
Smith (1978) aimed to determine whether there is any correlation between the historical
performance of a mutual fund and the growth in assets in the fund in subsequent time periods.
Based on the assumption that noting good performance investor will subsequently invest his
money into the mutual funds. The study exhibited that there was no significant correlation
between portfolio performance and either overall fund growth or new money added to the fund.
The second part of the analysis used the risk-adjusted basis as a measure of portfolio
performance. The results showed a positive correlation between performance and growth fund in
3 of the 8 years of the study. Although some indications are shown, there is not enough evidence
to draw a positive conclusion.
Lehmann and Modest (1987) aimed at ascertaining whether conventional measures of abnormal
mutual fund performance are sensitive to the benchmark chosen to measure normal performance.
They used two broad classes of portfolios in the empirical tests: those associated with the CAPM
and those associated with the APT. They found that the Jensen measure and Treynor-Black
appraisal ratios of individual mutual funds are quite sensitive to the method used to construct the
APT benchmark. The rankings of the funds are less sensitive to the exact number of common
sources of systematic risk that are assumed to impinge on security returns. There were
considerable differences between the performance measures yielded by the standard CAPM
benchmarks and those produced with the APT benchmarks, which suggests the importance of
knowing the appropriate model for risk and expected return in this context. They concluded that
the choice of what constitutes normal performance is important for evaluating the performance
of managed portfolios.
Grinblatt and Titman (1993) introduced a new measure of portfolio performance. In contrast to
the previous studies of mutual fund performance, the measure used in this study employed
portfolio holdings and did not require the use of a benchmark portfolio. They found that the
portfolio choices of mutual fund managers, particularly those that managed aggressive growth
funds, earned significantly positive risk-adjusted returns. They argued that the portfolio holdings
of an uninformed investor cannot be correlated with future assets return and an informed investor

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can predict when certain assets will have either greater or lower average return. Thus, the
investor can make profit by changing proportion of investment over a period of time. They
concluded that all portfolio managers will not be able to make superior returns.

Brown and Goetzmann (1997) proposed a new approach for determining management styles.
They claim that their classifications are superior to common industry classifications in predicting
cross sectional future performance, as well as past performance, and they also outperform
classifications based on risk measures and analogue portfolios. They believe and identify the
same with proof that several funds misclassify themselves. Some of this misclassification they
believe might be intentional, in that it works to improve ex post relative performance measures,
on average. Management styles are widely used as the basis for performance measurement and
compensation. Thus there is a great need for style classifications that are objectively and
empirically determined, consistent across managers and related to the strategy. Objectivity is
important because of the moral hazard inherent in allowing managers to self report their styles
without objective verification. Consistency is needed for the purpose of performance
comparison. A return based classification system can reduce the incentive to game the styles to
improve relative ex post rankings.
Walker (1997) had extensively used a data set of 222 mutual funds that were described by Fund
Watch as growth oriented and included funds in existence for sufficient time to have a historical
five year track record. He proposed that direct causal relationships exist between a fund's current
relative performance and historical performance rankings. He concluded that the using past
performance and widely accepted indicators of performance as predictors of success in mutual
fund selection are marginally successful. Significant specification errors, lack of consistency
among regression coefficients and path signs that contradict widely accepted financial theories
regarding diversification, risk, and cost show that investment selection success is impacted by
random chance or unobserved variables far more that predictable patterns. Finally, he portrayed
that identification funds that charge very low management fees and select a diversified group of
these funds.
Daniel, Grinblatt, Titman and Wermers (1997) introduced a new performance measure method
that forms benchmarks by directly matching the characteristics of the component stocks of the
portfolio being evaluated. The classified the characteristics into three distinctive components as
Average style (AS), Characteristic Selectivity (CS), Characteristic Timing (CT) and the sum of
these measures are the overall hypothetical return of a fund. In this research, they have used
Characteristic based approach, Carhart four factor model, GT measure and Jensen's one factor
model (One factor). This approach was basically designed to foresee whether the mutual funds
pick stocks that outperform simple mechanical rules and the evidence suggested that the average
mutual fund, in fact, succeeded with this approach. Aggressive growth, and growth fund had
shown greater performance and mean time generate high costs. This approach attributed
abnormal performance to those portfolio managers who change their investment styles over time,
implementing the styles when they have the highest expected returns. Their results mainly
signifies that mutual funds, more specifically aggressive growth funds shown selectivity ability,
but that funds shown no characteristic timing ability.

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Indro, Jiang, Patuwo and Zhang (1999) predicted the mutual fund performance through Artificial
Neural Networks (ANN). They emphasised 7 major variables of interest namely Annualised
return (Measured at the end of each year), Portfolio turnover, Price-earnings ratio, Price-book
ratio, Median market capitalisation, Percentage of Cash holdings, and Percentage of Stock
holdings. These explanatory variables then used to predict the mutual fund performance by
applying Jensen's Alpha. They hypothesised that whether the Artificial Neural Networks superior
to Linear models in predicting the mutual fund performance. The Neural networks employed
here are feed-forward networks with one hidden layer, seven input nodes corresponding to the
number independent variables and one output node corresponding to dependent variable. They
found that the superiority depends on the style of fund. in particular, Linear models were
superior to ANN for value funds and ANN approach was superior to Linear models for growth
and blend funds. They enumerated that if macro-economic variables used in correlation with
operating characteristics of funds, it would be more significant.
Rao (2001) hypothesised that mutual fund managers were able to follow a market timing strategy
means where the forecaster predicts when stocks will out-perform the riskless securities and
when riskless securities will out-perform stocks, but not predict the magnitude of relative returns.
This highlights that the mutual fund managers did not successfully time the market and good
stock selection skills.
Kothari and Warner (2001) used simulation procedures to study empirical properties of
performance measures for mutual funds. They also argued that the power of multifactor
benchmarks to detect abnormal performance of a managed portfolio had received little attention.
They concluded that standard mutual fund performance measures were unreliable and can result
in false inferences. It is hard to detect abnormal performance when it exists, particularly for a
fund whose style characteristics differ from those of the value weighted market portfolio.
Basso and Funari (2001) introduced a new operational methodology protocol called Data
Envelopment Analysis for measuring the mutual fund performance. Despite the fact, it
accommodates many inputs thus consider risk measures including subscription costs and
redemption costs. By applying the DEA indicated the importance of the subscription and
redemption costs in determining the fund ranking. The results suggested that the DEA
methodology for evaluating the mutual funds performance may usefully complement the
traditional indexes.
Peterson, Pietranico, Riepe and Xu (2002) had the prime objective to identify a concise set of
publicly available variables that together, were useful for explaining subsequent after-tax U.S.
equity tax performance. They found that the funds were historically tax efficient outperformed
comparable funds on an after-tax basis, funds that experienced large net redemptions particularly
large-cap value funds subsequently underperformed comparable funds on an after-tax basis.
Risk, Investment style, Past pre-tax performance, and expenses were important determinants of
after-tax and pre-tax returns. They identified that the portfolio turnover did not appear to be
related to future after-tax returns.
Annaert, Broeck and Vennet (2003) argued that outperformance of a portfolio compared to
benchmark perhaps purely because of chance. Thus, they decomposed the deviation from their

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expected return into a noise component and an efficiency score, which would be 100% if the
fund exhibited no underperformance. The Bayesian Frontier approach was used for decompose.
They found that European equity funds efficiency was positively related to fund size and
apparently large funds outperform small funds that perhaps indicate the existence of scale of
economies.
Prather, Bertin and Henker (2004) examined the mutual fund performance by using an integrated
approach to analyse a large set of mutual funds and a thorough list of fund specific
characteristics. The study covers the period of 1996-2000 and extensively considers 5000 distinct
equity funds. They have used multifactor regression model for analysis. The main fund specific
factors focused were Popularity variables, Growth variables, Cost variables, and Management
variables. Though the prior studies included only 5 to 8 characteristics, they included 25
individual fund specific factors. The analysis exhibited that Market capitalisation (Parameter
estimate: -1.015, t-statistic: -3.88), Cash-flow-to-book value (Parameter estimate: 15.7, t-
statistic: 4.44), Expenses ratio (Parameter estimate: -1.822, t-statistic: -5.36), and Funds under
management (Parameter estimate: -0.025, t-statistic: -2.74) were statistically significant at 1%
level. The Price-earnings ratio (Parameter estimate: 0.06, t-statistic: 1.71) was significant at 10%
level hence those were the fund specific factors majorly contributed for fund performance.
Weigand, Belden and Zwirlein (2004) attempted to compare the performance of the stocks that
were most heavily weighted in mutual funds versus the stocks that were most lightly weighted.
They found that mutual fund managers placed an average of 0.44% of the total wealth of their
funds in the more highly weighted stocks in 1999 and 0.53% in 2000. Fund managers invested an
average of 2.84% of their funds wealth in their most heavily weighted stocks in 1999 and 3.14%
in 2000. If the fund managers were superior stock pickers, individual investors might be able to
earn excess returns by following the implicit stock selections of these professional investors and
their research findings did not support this logic. They found that funds over 6-12 month periods,
heavily weighted stocks perform better than lightly weighted stocks. Thus, finally they identified
that the stock selection ability of fund managers were no better than individual investors.
James and Karceski (2006) examined the performance of retail mutual funds to mutual funds that
cater to institutional investors and by examining cross sectional differences in the performance of
institutional funds. The analysis revealed that big institutional funds without mates had earned an
average monthly excess return of 0.929% while institutional funds with mate earned 0.751%,
which was the lowest excess return among the fund type. They found evidence that the
institutional investors do not chase returns in the same way that retail investors do and there is no
significant relationship between fund inflows and past relative performance in the institutional
segment of the market, and the flow performance relationship of top performing institutional
funds was statistically different from top performing retail funds.
Lin (2006) examined three types of Taiwan mutual funds over various investment horizons. The
explanatory variables included in the regression were NAV, Current Yield, Turnover rate,
Expenses ratio, and Load charges. From the analysis, it was evident that expenses ratio
negatively correlated (Beta = -4.8556) when performance evaluated for 3 months horizon and
positively correlated for other investment horizons. There is no statistically reliable relation
between the performance with Current yield, turnover ratio, and load charges. He concluded that

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aggressive funds appear to be more attractive for both short-term and long-term investments and
performance of the fund was negatively correlated with expenses ratio and positively correlated
with Net assets value.
Gottesman and Morey (2006) addressed whether the qualification of a fund manager does matter
in terms of fund performance or not. The research exhibited that the fund manager holds CFA
designation, Master degree other than MBA, and Ph.D were unrelated to mutual fund
performance. The quality of the undergraduate degree was no longer significant at 10% level.
Finally they concluded, fund houses should recruit managers from top or near top MBA
programs.
Switzer and Huang (2007) examined whether small and mid-cap fund performance is related to
fund manager human capital characteristics including tenure, investment experience, education,
gender and professional training. The study exhibited that the CFA managers outperforms by
57.96 basis points than non-CFA managers at 10% level and managers posses MBA qualification
did slightly better than non-MBA managers but this was statistically insignificant and this
contradicts the findings of Aron A Gottesman Matthew R Morey (2006). Managers tenure,
investment experience, and fund style do not have significant effects on fund performance.
Overall smaller funds with lower expenses ratios tend to generate consistently better
performance and these results were consistent with Carhart (1997).
Redman and Gullett (2007) examined the factors that influence the performance of bond mutual
funds. They studied the performance through portfolio characteristics, management controlled
variables and bond market variables. The findings summarises that the F-statistic value for the
period 1997-2000 was 25.7 with R
2
of 0.45 and found that turnover ratio, manager tenure and no.
of holdings are not significant explanatory variables. For the period 2001-2003, the F-statistic
value stood at 187.3 with adjusted R
2
of 0.54 and it was apparent that turnover ratio, manager
tenure were not significant variables. The number of holdings for both the periods was
significant at 10% level. Fund age and Expenses ratio was significant for both the periods.
Cheong Sing (2007) iterated that fund size and expenditure significantly impact the performance
of funds. The author attempted exclusively to analyse the impact of size and expenses in this
research. In order to avoid the survivorship bias the non-surviving funds were also included in
the sample. It was evident that the large funds outperformed than small funds but performance of
large funds were not statistically significant for all holding periods at 5% level. Though the large
funds had low expenses ratio, the differences in expenses ratio was insignificant.
Rao, Ward and Ward (2007) found that investors may not fully take advantage of possible
portfolio risk reduction and higher returns if they exclude international mutual funds from their
portfolio. In their study they stated that performance can be evaluated with a simple, yet
theoretically meaningful measure that considers both average return and risk. During the study
period, foreign mutual funds appear to have more volatility and higher risk but have
outperformed U.S. mutual funds in nominal and risk-adjusted terms. Predicting in advance which
mutual funds would outperform is difficult and the cost of selecting the "wrong" mutual fund is
very high. Investors have to keep in mind that sound investment decision-making combines the
science of quantitative analysis with the art of qualitative judgment and reason.

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Knuutila, Puttonen and Smythe (2007) evaluated the flow patterns in Finnish bank-managed
funds were significantly different from the patterns in the United States. They also attributed that
bank-managed funds in Finland were on average underperformed than their independently
managed counterparts in terms of top performers, where performance was measured by
Morningstar stars and also the performance-flow relationship in Finnish funds, as a whole seems
to be non-existent due to random distribution of flows for bank-managed funds.
Evans (2008) researched on the association between a mutual fund manager's personal fund
investment and mutual fund performance. This enumerates whether managers with a minimal
ownership level have statistically different performance levels than managers who own more. He
found that managerial fund ownership varies widely with approximately one out of every 2
managers owning over $1,00,000 in the managed fund and one out of every five managers
owning over $10,00,000.
Haslem, Baker and Smith (2008) investigated the relationship between the performance and fund
characteristics. They regressed Expenses ratio, Net assets, Front-end load, Deferred load, 12b-1
fees, portfolio turnover, beta, holdings level of cash and dividend yield to measure the fund
performance. They concluded that the investors would be better off in low-cost passively
managed index funds and research also supported that expenses must be at least one and perhaps
two standard deviations below the peer-group mean for investors to have close to a 50-50 chance
of beating a relevant benchmark. It was evident from their research, the larger equity funds tend
to perform better than the smaller equity funds on account of economies of scale led to lowering
the expenses of the fund in turn maximises the portfolio return.
Leite and Cortez (2009) estimated and compared the performance of Portuguese based mutual
funds that invest in the domestic market and in the European market using unconditional and
conditional models of performance evaluation. The findings were that fund managers are not
able to outperform the market, presenting either negative or neutral performance.
Karoui and Meier (2009) had studied the performance and portfolio characteristics of 828 newly
launched US equity mutual funds over the period of 1991 to 2005. They found that portfolios of
new funds are typically less diversified in terms of number of stocks and industry concentration
and are invested in smaller and less liquid stocks. They suggest that new funds perhaps earn
high excess return in the beginning on account of current market conditions. They also provide
empirical evidence for short-term persistence among top performing fund starts, however, a
substantial fraction of funds drop from the top to bottom decide over two subsequent periods.
Ejara and Nag (2009) studied that whether managerial tenure has positive impact on mutual fund
performance or not. The impact on three and five year annualized returns is statistically
significant. The impact on ten year annualized return is positive but statistically insignificant.
This implies that while experience and the ability to plan on longer term basis helps managers
increase returns, the influence of such tenure decreases when we consider very long time
horizons.
Sensoy (2009) attributed that the fund's subsequent cash inflows would mainly depends on the
specified benchmark. He estimated that the magnitude of the expected incremental gain flows to
funds with mis-matched self-designated benchmarks is 2.3% of assets under management per

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year, which is 14.6% of the average annual flow to those funds. Indeed, 31.2% of these funds
specify a benchmark index that was "mismatched": alternative S&P or Russell size and
value/growth based benchmarks both better match these funds size and value/growth
characteristics and, more importantly, were more correlated with their returns. He referred to
these as funds corrected benchmarks. Among these funds, the average excess return R
2
with
actual benchmark was 70.6% versus 82.6% with the corrected benchmark. It was clearly evident
from this paper that for the development and dissemination of measures of mutual fund
performance that were well grounded in economic theory and not subject to gaming.
III. STUDIES RELATING TO SPECIFIC CATEGORIES OF MUTUAL FUNDS
Preskett (1994) accentuated that mid-cap funds had dominated all Companies in UK space over
last three years with six out of the top ten in the sector investing solely in FTSE 250 firms.
Overall, the best performer to the end of March 2007 was Ashton Bradbury's Old Mutual UK
Select Mid Cap, which was up 113.19% on a bid-to-bid basis according to Morningstar. Second
was Paul Spencer's Rensburg UK Mid Cap Growth, which generated 112.89% over the same
timeframe. Mid-cap funds from Schroders, Allianz, Aberdeen and HSBC also featured in the top
ten, delivering 90% plus returns.
Tessitore and Usmen (2005) attributed to decompose the performance of a group of FOF that
hold closed end funds with exposure to stock markets around the world. They analysed two
major variables such as fund selection and country allocation. They found that over the sample
period of the study, the FOFs had positive NAV but negative country allocation performance
resulted in an overall slightly negative performance and it was notable that it was a trade-off
between the two effects.
Agache and Huys (2006) focused to compare the net of fees performance of FOF and their single
fund counterparts. This study revealed that FOFs slightly underperformed global equity funds in
2000 by -0.54% and the difference was not statistically significant at 5% level. FOFs
underperformance had widened in the 2001 by 2.74% and statistically significant at 5% level.
They observed that FOFs tend to outperform or underperform their single fund counterparts in
one country; they tend to do so in the same way in the other four countries. Evaluation in terms
of average annual volatility exhibited that FOFs had a significant lower volatility than their
single fund counterparts. They concluded that the FOFs can do better, even in both bullish and
bearish markets and it really makes sense as well as unidirectional markets, a right market
consensus and diversification benefits work in favour of FOFs.
Bertin and Prather (2008) addressed the management structure and its impact on FOF
performance. They found that FOF provided cost effective methods of diversification and the
performance compares favourably with equity funds during the study period and also inferred
that FOFs with individual or identified team managers outperform their unidentified team
managers.
Dor, Budinger, Dynkin and Leech (2008) studied whether single index benchmark or
constructing peer benchmark index serve as a tool to evaluate the mutual fund performance.
They have selected multi sector bond funds to analyse how style analysis can be used to
construct peer manager style benchmarks that allow proper measurement of a funds risk relative

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to its competitors. Primarily they focused to state that a single index may not serve as an
adequate passive benchmark for certain mutual fund categories, even if the index includes all
relevant asset classes. They found that this technique was sensitive to the asset class
specification, which should span the investment universe of the funds in question and
inappropriate or inadequate choice of asset classes may lead to wrong inferences.
Subramaniam (2008)

noted that the small size and a lower base do not give any substantial
indication that the mid-cap space should perform well. Ultimately, it is the valuation that
matters. Even the warren Buffett way of selecting stocks also suggests the same. He believed in
the concept of investing from a business perspective and emphasizes on price being a major
factor in stock selection. In other words, we can say, what to buy, and at what price, is of
paramount importance. Many market experts believe that mid-caps are available at a relatively
lower valuation as compared to the large-caps. This is because the price we pay determines the
rate of return. Many market experts believed that mid-caps are available at a relatively lower
valuation as compared to the large-caps. Mid-caps have continued to put up superb financial
performance and are thus available at a lower P/Es.
Chander (2008) found that the mid cap rally had excited the retail category investors and equity
investment based on sound fundamentals (or a sound investment approach in the case of mid cap
fund) bought with a long-term investment time-frame (at least 3-5 years) stands a good chance of
delivering value to the investor. Investors with some appetite for risk must undoubtedly consider
adding mid cap funds to their existing mutual fund portfolio. Existing is the operative word
over here. It means that investors must have a portfolio to begin with, preferably with large cap
diversified equity funds forming a substantial chunk. It is all very well to invest in mid cap
funds, but they should not be your frontline mutual fund investment and they should not have a
disproportionately high weightage in your portfolio.
Venus and Syed (2008) emphasised that mid-cap funds are the haute couture of the mutual fund
industry. BSE MIDCAP Index accounted an annualised return of 39.41% in the past three years,
the SENSEX returns of 34.15% pale in comparison. Mid-caps finally have their place in the sun
with virtually every mutual fund house having a dedicated fund in its stable. Mid-caps tend to
combine the characteristics of large-caps and small-caps by offering more growth than the
former and less risk than the latter. They score over small-caps by being more established,
financially more resilient and more liquid.
Badhani (2009) envisaged that the way to reduce the risk, after having identified a sound mid cap
investment is to always have a long investment time frame and observed equities are the least
risky asset over the long-term and the riskiest assets over the short-term. So if the investor have
taken the mid cap route to generate wealth be prepared for the long haul. This way investor will
be relatively unaffected by intermittent volatility because investor are clear that they expect to
remain invested for at least 5 years.
Chander (2009) noted that the Mid-cap funds should represent 12 to 25 per cent of a long-term
portfolio. Picking a good fund in this category is one of the toughest exercises for an investor
because few funds are solid long-term performers. When a fund establishes a great track record,
assets explode and the manager often cannot find enough good small companies to buy.

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Thenmozhi and Thomas (2009) noted that Planning for retirement and how to invest the money
saved, presents a wide choice of investment options. In the stock market mid-cap stocks have
been called "the forgotten asset class" and "the road to wealth" in stock investing. Selecting mid-
cap funds as a part of retirement planning investments may provide extra gains to a retirement
portfolio. Mid-cap funds are a good choice for adding long term growth to investments. There
are a large number of choices in mutual funds and ETFs to invest in mid-cap stocks. Review the
funds stock holdings, management fees and return history before selecting any fund.
Vikkraman, Varadharajan and Selvakumar (2010) enumerated the performance of top three
mutual funds in the Equity, Income and the Balanced funds category based on their return. The
main objective of this research is to find out the risk and return and study the performance of the
funds and to compare it with the market return. The study revealed that the performance of the
funds with the market over the three years and whether the funds managers have good timing
abilities and proper stock selection capacities and also the behaviour of the funds during the up &
the down market were analysed. They found most of the funds performed well in the up market
and yielded negative returns below the market level during the down period. The conservative
income funds alone gave positive returns. The timing abilities and the stock selecting capacities
of the fund managers are nil or very poor which might be the reason for the performance of the
funds.
Srivastava and Gupta (2010) attempted to determine the performance of growth oriented equity
schemes of Indian mutual funds on the basis of monthly returns compared to benchmark returns.
The findings of the study suggest that majority of the mutual funds outperformed the market
benchmarks. It is found that, Sahara mutual fund and Birla Sunlife outperformed the others in all
the evaluation techniques employed. The results suggest that although the funds outperformed
the benchmarks but even then the Indian fund managers are required to put more efforts for
diversifying their portfolios as they are not diversified properly.
IV. METHODOLOGICAL APPROACHES IN MEASURING MUTUAL FUND
PERFORMANCE
A. TREYNORS PERFORMANCE MODEL
Treynor (1965) emphasised that in a perfect capital market no securities would be incorrectly
priced. In such conditions all well diversified portfolios will move with market and portfolio
yields high return when market provides high returns vice-versa. The very prominent existence
of business risk and financial risk had not been addressed in the research. His measure cannot
capture the portion of variability caused by lack of diversification hence this would not be
appropriate to measure the past performance.

R
P
= Return on the fund being evaluated in period t R
F
= Return on the risk less asset

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ij
= Sensitivity to benchmark [Reward-to-Volatility]
B. SHARPES PERFORMANCE MODEL
Sharpe (1966) had shown that performance can be evaluated with a simple yet theoretically
meaningful measure that considers both average return and risk. He enumerated that the
differences could be detailed by expenses ratio, lending support to the view that the capital
market is highly efficient and that good managers concentrate on evaluating risk and providing
diversification, spending little effort (and money) on the search for incorrectly priced securities.
Sharpes measure evaluates the performance of the portfolio manager not only on the basis of the
returns but also on the extent and degree of diversification of the portfolio attained. If the
portfolio is fully diversified, implying that it does not contain any nonsystematic risk.

R
P
= Return on the fund being evaluated in period t R
f
= Return on the risk less
asset
ij
= Total Risk [Reward-to-Variability]
C. JENSENS PERFORMANCE MODEL

Past studies indicate that the sensitivity of fund performance to the benchmark used to proxy the
market return. Assume that using a large capitalisation Index as benchmark say BSE 200 results
in a positive bias for a sample of small capitalisation funds. Elton (1993) enumerated that the
positive performance reported in Ippolito (1989) resulted from an incorrect benchmark rather
than from superior security selection of fund managers and this is commonly known as
Benchmark error. In order to avoid benchmark error Jensens modified alpha can be used to
understand excess return generated by the fund.

R
Pt
= Portfolio Return for the periodt R
ft
= Return of risk less asset in
period t
ij
= Sensitivity to benchmark R
Lt
= Return of Large stock index for
the periodt

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R
St
= Return of Small stock index for the periodt R
Ft
= Return of Foreign stock index
for the periodt
R
Bt
= Return of Bond index for the periodt
P
= Abnormal Return
Pt
= Error term of regression
D. FAMA AND FRENCH THREE FACTOR MODEL
This model measures the fund performance by excess returns (Alpha). It considers sensitivity of
risk premium, sensitivity of return difference of small and large cap stocks and sensitivity of
return difference of value and growth stocks.

R
P
= Portfolio Return R
F t
= Return of risk less asset in
period t
P
= Abnormal Return = Sensitivity factor
SMB = Return to small cap stocks minus return to large cap stocks
HML = Return to Value stocks minus return to growth stocks
Pt
= Error term of regression
E. CARHART MODEL
The Carhart measure is an extension of Fama and French (1993) 3-factor model and is as
effective as the four factors Jensen measure. According to this model, in the absence of stock
selection and timing abilities, the expected return for a fund is the sum of the risk free return and
the products of the betas with the factor risk premium.

R
P
= Portfolio Return R
F t
= Return of risk less asset in period t
P
= Abnormal Return SMB = Return to small cap stocks minus return to large cap
stocks
HML = Return to Value stocks minus return to growth stocks
Pt
= Error term of regression PR1YR
t
= Prior year return to current year return

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CONCLUDING REMARKS
The main scope of this bibliographic review is to accentuate and enumerate the insights of
mutual fund performance measurement models, which facilitate the Researchers, Academicians,
Fund Managers and mutual fund distributors. It was evident from the review that Treynors
model considers only the systematic risk component to measure the fund performance and it fails
to identify the impact of firm-specific risk. Sharpes model considers the total risk and arrives at
the performance on risk-adjusted basis. The Sharpe, Jensen, Fama & French and Carhart models
explain only the sensitivity factor with respect to various benchmarks and do not explain the
sensitivity of the fund specific characteristics. Performance models, which mainly considered
fund specific characteristics, did not consider market characteristics.
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ZENITH International Journal of Business Economics & Management Research

Vol.2 Issue 4, April 2012, ISSN 2249 8826

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