HANKEN

Mutual Fund Performance

A study of how Finnish equity funds perform compared to the market
Toni Sundqvist 108830 & Christoffer Hrus 071000 4/26/2013

Table of Contents
Table of Contents ....................................................................................................................... 1 1 Introduction ............................................................................................................................. 1 1.1 Purpose ............................................................................................................................. 2 1.2 Delimitation ...................................................................................................................... 2 1.3 Construction of term paper ............................................................................................... 2 2 Theory ..................................................................................................................................... 2 2.1 Capital Asset Pricing Model (CAPM) ............................................................................. 2 2.2 Single Index Model .......................................................................................................... 3 2.3 Performance ratios............................................................................................................ 3 2.3.1 Jensens measure (Jensens Alpha) ........................................................................... 3 2.3.2 Sharpe measure ......................................................................................................... 4 2.3.3 Treynors measure ..................................................................................................... 4 3 Data ......................................................................................................................................... 4 4 Methodology ........................................................................................................................... 6 4.1 Capital Asset Pricing Model (CAPM) ............................................................................. 6 4.2 Jensens Alpha.................................................................................................................. 6 4.3 Treynors Measure ........................................................................................................... 7 5 Results ..................................................................................................................................... 7 5.1 The Chain Index ............................................................................................................... 7 5.2 The performance ratios..................................................................................................... 9 6 Discussion ............................................................................................................................. 10 References ................................................................................................................................ 12

1 Introduction
The fund market consists of equity funds, bond- and other fixed-income funds as well as mixes between these two. Mutual funds are a kind of investments that is made up of a pool of funds collected from many investors. Mutual funds account for more than 90% of investment company assets. Assets in the U.S. mutual fund industry were valued approximately $ 10 trillion in 2009. According to Suomen Sijoitustutkimus (2013), all assets in the Finnish mutual fund industry in February 2013, account for over 67 billion, of which almost 24 billion are placed in equity funds. Each mutual fund has a specified investment policy. An example of an equity fund policy might be the mutual fund only invests in domestic stocks. The policy of a money market fund can, for instance, be that the fund only invests in shortterm money- instruments. (Bodie, Kane & Marcus 2011: 124-125) Commonly individual investors do not trade securities for their own accounts. Instead, these investors direct their assets to investment companies that purchase securities on its customers behalf. (Bodie, Kane & Marcus 2011: 120). There are plenty of mutual funds to choose between. A rational investor will search for the mutual funds that can offer the highest riskadjusted returns. This investor will want to obtain the highest possible return for the smallest amount of risk. Every alternative must also be weighted against the market. The investor should not be satisfied with a return of, for instance, 5 % if the market can offer him 10 % return with the same amount of risk. There is no evidence suggesting that professionally, or actively, managed portfolios can beat the market consistently. Bodie, Kane and Marcus (2011: 133) point to a research made by Investment Company Institute, from 2009, showing that the returns of a passive portfolio between 1972 and 2009 would have been better than those of the average equity fund. On the other hand, this same research shows that the better manager in one period tended to be better managers also in the following periods, which means that a good manager with some consistency can outperform their competitors. (Bodie, Kane & Marcus 2011: 397.) The Finnish mutual fund market evolved much later than, for instance, the American mutual fund market. The law enabling the creation of mutual funds in Finland was established as late as in 1987. (Suomalaisia arvopapereita Oy 2010.) Because of this, the Finnish mutual fund market is less developed compared to its counterparts in some other countries. 1

1.1 Purpose
The purpose of our research is to find out how Finnish mutual funds succeed compared to a benchmark index. Our interest in this subject was awakened by the fact that, according to research, most mutual funds do not outperform the benchmark over a long period of time. The period of this study is five years, ranging from 2008 to 2013.

1.2 Delimitation
Given the amplitude of the subject, we have made certain limits in the selection of the mutual funds. We have decided to study the returns of some of the biggest Finnish equity funds investing in domestic stock. The funds chosen are managed by various fund management companies. We specifically chose equity mutual funds because the stock markets are more volatile compared to the bonds market, and therefore, we think the results will be more significant.

1.3 Construction of term paper

In the first chapter we introduce the subject of this paper. We also describe the purpose and delimitation of this study. In the following chapter we are going to explain the chosen models, as well as some theory behind the models used in our analysis. In the third chapter we will present our data, its origin and how we have used this data for our purposes. The fourth chapter will contain the methodology we have used for our research. We will explain how the chosen models have been used and implemented. In the fifth chapter the results of the study are presented, both in text and in various tables/charts. Finally, in the sixth chapter, we will discuss the results and draw some conclusions from our findings.

2 Theory
In this chapter we will describe the performance measures used in our analysis. All the theories used in our study all have their origins in the Capital Asset Pricing Model (CAPM), including the Jensens Alpha, which will serve as our main measurement tool for analysis.

2.1 Capital Asset Pricing Model (CAPM)

( )
where

+ (
E(r) =

- )
expected return, = the risk-free rate, = the asset beta,

The CAPM is a theoretical model, standing as a basis for most of the most common theories around financial analyses. As the name suggests, this model is used to theoretically determine the price of capital assets. Basically the CAPM is built around two things: Risk premium. Security-specific represented in a security-beta compared to a broader market risk premium. The risk-free rate.

The CAPM gives us an expected return-beta relationship, which is portrayed in the security market line (SML). This means that according to this theory, the return on any investment will coincide with the SML provided that the market is efficient. This security-specific return equals the market risk premium multiplied by the systematic risk (represented in the beta). (Bodie, Kane & Marcus 2011: 308-317.)

2.2 Single Index Model

=
where

+
= Excess return on stock I, = the stocks alpha, = the residual return = the stocks beta,

A single-index model is used when comparing a security to one market index, this index serving as a proxy for the whole market. In this analysis the formula for this model is not used in its original form, but it is a foundation for the performance measures used in this study. Specifically, Jensens Alpha originates from the single-index model, created by solving the alpha value out of the equation. (Bodie, Kane & Marcus 2011.)

2.3 Performance ratios

Evaluating performance based on average return is not useful. Returns should be adjusted to risk before they can be correctly compared. The performance ratios take the risks of the mutual funds and rank the performance of them. There are three main performance ratios. These ratios are the Sharpes measure, Treynors measure and Jensens measure. (Bodie, Kane & Marcus 2011: 849-850) 2.3.1 Jensens measure (Jensens Alpha) =
where

)]
= portfolio return, = the risk-free rate, = the portfolio beta, =

= the portfolio alpha,

return on the market portfolio

The Jensens measure is based on the CAPM model, and assumes that portfolios are well diversified and that unsystematic risk is eliminated. Jensens measure gives the alpha of an investment. This means it gives the excess return on a portfolio compared to the CAPM expected return. (Bodie, Kane & Marcus 2011: 850.) Since we are going to compare the return of the different mutual funds to the return of the market portfolio, we see this measure as our main model in our study. Jensens alpha returns a value that is easily interpreted and corresponds to the purposes of our study. 2.3.2 Sharpe measure
where

The Sharpes measure is a reward-to-volatility ratio, which means it divides average portfolio excess return over a period by the standard deviation of returns over the same period (Bodie, Kane & Marcus 2011: 850.) This means that this ratio measures the total risk of the portfolio instead of only systematic risk. Our chosen mutual funds hold diversified portfolios, thus the unsystematic risk is eliminated. The volatility ratios are very close for every fund observed, therefore the Sharpe ratio wouldnt provide any new comparable information. This is why we have chosen not to use the Sharpe ratio as a measurement in our study. 2.3.3 Treynors measure
where = portfolio return, = the riskfree rate, = the portfolio beta

The Treynors measure is a ratio of excess return to beta. Like Sharpes measure, Treynors measure gives excess return per unit of risk. Instead of the total risk, Treynors measure uses only systematic risk. This measure compares excess return to the beta value of the security. (Bodie, Kane & Marcus 2011: 850.) This means the Treynors measure can be used when you want to measure the performance of a well-diversified portfolio, which is exactly what we have done in our study.

3 Data
For this study, we have chosen eleven equity funds investing in domestic stock. As benchmark we have chosen the OMX Helsinki Benchmark CAP GI. Originally, our intention was to collect the historical price data for a ten year period ranging from the beginning of

2003 until March 2013. However, every fund company were not even able to provide us with data from the beginning of 2008, which means that the data used in our study will range from April 2008 to January 2013. We have some different criteria for the funds included in the study. First of all, the funds must have been founded before 2008. They must be growth funds with at least two and a half billion euros in assets, where dividends are reinvested. It must also be possible for private investors to invest in these funds. The funds cannot either be so called, funds-in-funds. We have used Morningstar (2013) to gather information about Finnish equity funds. After ruling out the funds that do not meet our criteria, we have eleven mutual funds left that will be used in our study. The historical daily price data of the chosen mutual funds have been collected either by calling the fund company and asking for the data, or from the fund companies web sites. After this we have converted the daily prices into monthly prices. To get benchmark data we have used information from Nasdaq OMX Nordic (2013), which we have chosen because this index matches the characteristics of the funds. This index has a cap of ten percent maximum for each stock and is calculated based on total return. Thus, the index matches the characteristics of the funds.
Mutual Funds Aktia Capital B Danske Invest Finland K Danske Invest Suomi Osake K Danske Invest Suomi Yhteisosake K ICECAPITAL Finland Equity 1 K Nordea Suomi Kasvu OP-Delta A OP-Suomi Arvo A SEB Finlandia B UB HR Suomi Kasvu landsbanken Finland Value B Table 1: Mutual fund data (Morningstar 2013) Average market value (million EUR 2818 4712 5118 5044 2941 4029 5102 3372 4851 4598 2886 Beta 0,920 0,974 1,005 1,015 1,017 1,055 0,989 0,961 0,989 0,985 0,984

4 Methodology
As mentioned earlier, our purpose of this study is to find out whether Finnish equity mutual funds can outperform their benchmark. The historical price data we have collected are daily numbers. Therefore, we have used the closing prices of the last trading day every month to obtain monthly values. With the following formula we have calculated the monthly arithmetic returns of each mutual fund, as well as for the benchmark

As risk-free rate we have used the 1-month Euribor rate for each month studied. This allows us to compare each months return with a risk-free rate for the same time period. Since the 1month Euribor rate is listed as a simple annual rate, we have divided the quotations by twelve to obtain a comparable rate. The 1-month Euribor historical data is collected from Euriborinfo (2013). The portfolio betas of the mutual funds are calculated through a regression analysis of each mutual fund against the benchmark index. For simplicity we have used the SLOPE function in Microsoft Excel, feeding it with appropriate monthly data.

4.1 Capital Asset Pricing Model (CAPM)

To simplify future calculations, we constructed a particular sheet in Excel where we calculated the expected returns, according to CAPM, of the mutual funds for each month. As market return ( ) we have used monthly historical data from the benchmark index. We also

created a column for monthly market premia by subtracting the benchmark by the according risk-free rate. Finally we computed the monthly expected returns for every asset in our study by using the following formula: ( ) + ( - ).

4.2 Jensens Alpha

Due to us having already calculated the expected returns, we have immensely simplified the task of computing the Jensens Alpha. The monthly Jensens Alpha values are computed by simply subtracting the expected return values, ( ) , from the observed returns ( ). The complete formula for calculating Jensens Alpha is: = [ + ( )].

After doing this, we have computed an arithmetic mean value for all the monthly Alphavalues to assess how successful the mutual funds have been compared to the benchmark index. If a funds Alpha value is negative, its return lies below the Security Market Line (SML), which is described in chapter 2.1. If the value is positive, the return of the portfolio lies above 6

the SML. To get a clearer look at the performance of different time periods, we have also computed yearly averages from our values.

4.3 Treynors Measure

To compute the Treynors measure we have used the monthly observed returns ( ) of the mutual funds, as well as of the benchmark index, and subtracted these by the risk-free rate ( ) for each particular month. We have divided the results of these subtractions by the betas ( of the mutual funds. The formula for calculating the Treynors measure is: )

This measure gives us monthly Treynor values for each mutual fund. After this, we have computed an arithmetic mean value from all the monthly values again to determine the success of these funds. To evaluate the performance of the funds, we compare the Treynor values of the funds to the Treynor value of the benchmark index

5 Results
Our purpose of the study is to compare the performance of chosen mutual funds to the market. As earlier mentioned, we are going to use two different measures. The Jensens Alpha is our main measure, but we have also included the Treynors Measure in our study. However, as an overview, we are first going to take a general look at the performance of the funds through the creation of a chain index.

5.1 The Chain Index

To get a clear picture of the performance of the mutual funds, we have created a chain index running through the entire period of our analysis. The difference between the chain index and our performance ratios is that the chain index does not take risk into consideration; it just measures the historical performance. Every mutual fund has a starting value of 100% and develops according to the performance of the funds. The method basically shows the development of a certain investment over the course of our research period. To further visualize the spread of our survey data, we have created a graph of the best and the worst performers of our study. The benchmark index is also portrayed in this graph.

120,0 % 110,0 % 100,0 % 90,0 % 80,0 % 70,0 % 60,0 % 50,0 % Danske Suomi YhteisOsake K OMXH Benchmark Cap GI OP Delta A

april 2008

april 2009

april 2010

april 2011

augusti 2008

augusti 2009

augusti 2010

augusti 2011

april 2012

december 2008

december 2009

december 2010

december 2011

augusti 2012

Chart 1: Chain index of best and worst performers compared to benchmark

The last value for each fund in the chain index basically shows todays percentage value of the investment made in the beginning of our study period. We have illustrated this in the following chart.
10% 8% 6% 4% 2% Total Return 0% -2% -4% -6% -8% -10% Chart 2: Final values compared to April 2008, including the risk-free rate and benchmark index. OP Delta A landsbanken Finland Value B Nordea Suomi Kasvu SEB Finlandia B Icecapital Finland Equity UB HR Suomi Kasvu Danske Finland K Danske Suomi Osake K Aktia CAPITAL B Riskfree Return OP Suomi Arvo A OMXH Benchmark Cap GI Danske Suomi YhteisOsake K

december 2012

As can be interpreted from the chart, only one mutual fund, OP Danske Suomi Yhteisosake, has outperformed the benchmark over this period. In addition to this particular fund, only OP Suomi Arvo A has managed to outperform the risk-free rate over this research period. Except for these two funds, three funds have a positive value compared to April 2008, and six funds have actually decreased the value of an investment made in April 2008.

5.2 The performance ratios

In this section we present the two performance measures we have decided to use in our study. We have chosen to present our results in a table containing the Jensen and the Treynor values. The betas of the funds also occur in the table, as well as the accumulated returns that we described in section 5.1. The betas of the funds are all close to 1, which can be explained by our choice in a particular type of fund.

Performance Measures
Total Period Of Study
Aktia CAPITAL B OP Delta A OP Suomi Arvo A Nordea Suomi Kasvu Danske Suomi Osake K Danske Suomi YhteisOsake K Danske Finland K landsbanken Finland Value B SEB Finlandia B UB HR Suomi Kasvu Icecapital Finland Equity OMXH Benchmark Cap GI Riskfree Return

Beta () Jensen's Alpha

Treynor's Measure

Accumulated Return

0,920 0,989 0,961 1,055 1,005 1,015 0,974 0,984 0,989 0,985 1,017 1,000 0,000

-0,06 % -0,32 % -0,02 % -0,19 % -0,09 % 0,02 % -0,10 % -0,25 % -0,17 % -0,15 % -0,17 % 0,00 %

0,0021 -0,0005 0,0025 0,0009 0,0019 0,0029 0,0017 0,0002 0,0010 0,0012 0,0011 0,0027

4,16 % -10,09 % 6,58 % -4,51 % 2,19 % 8,73 % 1,32 % -7,00 % -2,93 % -0,88 % -2,34 % 8,17 % 6,38 %

Table 2: Jensen and Treynor values,

As can be interpreted from table 1, the only fund to have a positive Jensens Alpha is the Danske Suomi Yhteisosake K fund with an Alpha value of 0,02 %, It means this particular fund is the only one of our eleven that has outperformed the market over this research period. For instance, the alpha of the worst performing fund, OP Delta A, is -0,32 %. These values match the values presented in our chain index, in section 5.1. The same phenomenon is seen in the evaluation of the Treynor measure. The only fund to have a greater Treynor value than the benchmark index is the Danske Suomi Yhteisosake K fund, with a Treynor value of 9

0,29 % compared to the markets Treynor of 0,0027, while the worst performing fund, OP Delta A has a Treynor value of -0,0005.

Yearly Jensen's Alpha

Aktia CAPITAL B OP Delta A OP Suomi Arvo A Nordea Suomi Kasvu Danske Suomi Osake K Danske Suomi YhteisOsake K Danske Finland K landsbanken Finland Value B SEB Finlandia B UB HR Suomi Kasvu Icecapital Finland Equity

2008 -0,50 % 0,10 % 1,04 % 0,06 % 0,05 % 0,16 % -0,36 % 0,31 % 0,78 % 0,25 % -0,23 %

2009 0,63 % -0,31 % 0,06 % 0,14 % 0,00 % 0,15 % 0,44 % 0,19 % -0,46 % -0,39 % 0,02 %

2010 -0,16 % -0,72 % -0,05 % -0,38 % -0,38 % -0,29 % -0,33 % -0,09 % -0,17 % -0,14 % -0,19 %

2011 -0,45 % -0,43 % -0,57 % -0,49 % -0,09 % 0,07 % -0,37 % -1,05 % -0,80 % -0,07 % -0,21 %

2012 -0,03 % -0,20 % -0,37 % -0,30 % -0,02 % -0,05 % 0,00 % -0,53 % -0,09 % -0,29 % -0,37 %

Table 2: Yearly Jensens Alphas

In table 2, the alpha values of the funds are presented on a yearly basis. The conclusion that can be drawn from this table is that it seems as it some years, for instance in 2010, has been more difficult for the funds to position themselves above the Security Market Line (SML) than other years, for example in 2009. For instance, every fund has a negative alpha in 2010, while almost all funds have a positive alpha in 2009.

6 Discussion
As earlier mentioned, research suggests that mutual funds usually do not outperform the benchmark index over a long period of time. Our purpose with this study was to examine whether this phenomenon can also be explained for Finnish mutual funds investing in domestic equity. To complete this study, we needed numerical historical price data from funds. This proved to be more difficult than we expected initially. For some banks, Danske Bank for instance, this price data of their funds is available on their web sites. For most funds, however, we personally had to contact the banks and ask for price data. On the contrary, historical data of the benchmark index was easier to access from Helsinki Stock Exchanges web site. As anticipated, our research showed similar results to that of studies published in the past on the same subject. Only one of our chosen funds, specifically Danske Suomi Yhteisosake K, outperformed the market benchmark over the holding period of almost five years. In addition to this one, only OP Suomi Arvo A, managed to top the risk-free rate over the period of 10

study. Over half of our survey data (six out of eleven) showed a negative total return over the period, this even though we disregarded the time value of money. From a customers point of view, we have also left out any consideration of fund commissions, which would further drive down the value of an investment. As mentioned in the introduction, it is difficult for fund managers to beat the market consistently (Bodie, Kane and Marcus 2011: 133). One reason for this might be that the mutual funds are strictly bound by policy and laws. Another reason is that mutual funds are facing a variety of additional costs that do not affect indeces. Such additional costs might be e.g. trading costs or bid-ask spreads. However, occasionally, fund managers are able to outperform the market, which can be seen in table 2. Our results suggest that periodically there is a mutual difficulty for fund managers to outperform the market. This difficulty seems to move in cycles. For instance, in 2008 and 2009, almost every fund outperformed the benchmark index, while in 2010, every fund had a negative alpha value. To sum up our discussion, we have concluded that during our holding period the average equity fund was not a good investment. Just like research suggests, our results suggest that investing in a passively managed market index is a better investment than an actively managed equity fund. In addition to the fact that market indexes return better than mutual funds, the costs of investing in a market index are also lower than that for the mutual funds. Hence, our suggestion is to invest in market indexes rather than equity funds.

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References
Bodie, Z., Kane, A., Marcus, A. (2011). Investments and Portfolio Management. The McGraw-Hill Companies. New York. Euribor-info (2013), Available 7 March 2013, from http://www.euribor-info.com/en/euribor1-month Morningstar (2013), Available 4 March 2013, from

http://www.morningstar.fi/fi/fundquickrank/default.aspx Nasdaq OMX Nordic (2013), Available 6 March 2013, from

http://www.nasdaqomxnordic.com/indexes/historical_prices/?Instrument=FI0008902291 Suomalaisia arvopapereita Oy (2010), Available 8 March 2013, from

http://www.porssitieto.fi/kirjoitus/suomalaisia-arvopapereita.html Suomen sijoitustutkimus (2013) Available 8 March 2013, from

http://www.sijoitustutkimus.fi/2013/02/lehdistotiedote-helmikuu-2013/

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