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A Study On Performance Evaluation of

Mutual Funds
1. Abstract:The following paper

of the mutual fund

on Performance Evaluation of mutual funds provides an overview

industry in Pakistan. The paper discusses three different performance

evaluation models Sharpe ratio, Trey nor measure and Jensen Differential. Worldwide these
models are being used for evaluating the performance of mutual fund
. In the context of

this paper two mutual funds have been selected for evaluation purpose. This paper provides
practical implications of the models and discusses how these models can help investors make
better investment decisions. The mutual fund industry of Pakistan is still a growing industry but
the industry has great potential. Investment in mutual funds is a better investment option because
mutual funds are less risky and provide greater returns. Over the past years large numbers of
investors have moved to this investment option. The mutual fund industry has great potential to
grow.

1. Introduction:The first mutual fund

introduced in Pakistans market was in 1962. This mutual fund

offered was by the National Investment trust of Pakistan (NIT) this was the first open-ended
mutual fund. A number of investors had shown interest in these funds. Later in 1966 the
Investment Corporation of Pakistan was established. This corporation offered 26 close-ended
mutual funds. These mutual funds were privatized by the government
of Pakistan in

2002. Twenty-five out of these twenty-six mutual funds were split into two lots. A lot of bidding
took place the first half comprising of twelve funds was sold to ABAMCO Limited. Nine out of
the twelve funds were merged in one close-ended fund and name as ABAMCO capital fund. A

few of these funds were not merged because of the disputed created by the certificate holders of
the funds. These funds were treated as a separate entity and named as ABAMCO Growth Fund
after the general meeting held in Dec, 2003. The second lot (Lot-B) of the funds was acquired by
PICIC Asset Management Company Limited. All the thirteen funds were merged into one single
close-ended fund and named as PICIC Investment Fund. At present there are forty-three openended and twenty-two close-ended funds offered in the market. All mutual funds in Pakistan are
registered and legally established in the format of a trust, under the trust act of 1882. These
mutual funds are regulated by the Security
Exchange Commission of Pakistan (SECP)

which licenses each asset management company in strict compliant with the NBFC rules, 2003.
The Pakistans mutual fund industry is shown great potential over the past years. It has been
observed that a large number of investors are investing in mutual funds
. Because of the

growth potential and increase in investors, asset management companies are coming up with
different investment schemes that fulfill different investors needs. To name a few 1. Balance
Scheme, 2. Asset Allocation Scheme, 3. Shariah Compliant (Islamic) Scheme, 4. Money Market
Scheme, 5. Income Funds and 6. Aggressive Fixed Funds. These funds are of different types that
give different returns and have differing risks. These funds suite different investors based on their
investment decision i.e. aggressive or reserve. The government of Pakistan has played a vital role
in the development of the mutual fund industry. The mutual funds
and asset

management companies have to follow strict rules and regulation set by the government. The
government has established the Central Depositary Company (CDC) which electronically
manages the ownership of the funds. These reforms have helped in increasing the confidence of
investors towards investing in these funds. This is a great step towards economic prosperity as
the development will lead to improved living standards of individuals. This can be achieved
through the introduction of different species of mutual funds and their performance. The success
of this sector depends on the performance and the roles of regulatory bodies. The excellent
performance of these regulatory bodies will help increase the popularity of Mutual Funds
significantly. (Shah and Hijazi, 2005)
Mutual fund is a collective investment scheme, which specializes in collecting a pool of money
from a group of investors. The collected money is used for investment purpose. Mostly, this
money is invested in securities such as stocks, bonds, money market instruments and similar
investments. The investments made from the investors money are strictly in accordance with the
guidelines of the conservative document of the fund. Mutual funds are operated by asset
management companies for investors who cannot directly invest in securities. The fund managers
professionally manage the investment in a diversified portfolio of equities and debt instruments
i.e. TFCs and Govt. securities and other securities in a diversified manner so that risk is reduced
and returns are appreciated. A mutual fund can generate profits from two different sources, which
are: Dividend and Capital Gains. The income earned through these investments and capital

appreciation realized is shared with the shareholders in the portion to the number of units owned
by them. A mutual fund provides liquidity, portfolio management expertise, risk diversification,
and stability to stock market
and it also mobilizes savings by attracting funds from small

investors.
Mutual funds

basically are of two types, open ended and close ended. The open ended

mutual funds

are created on a continuous basis and can be bought and redeemed though

management companies. The funds are bought and redeemed at the prevailing Net Asset Value
(NAV). Open-ended funds cannot be traded in the secondary market. On the other hand closeended funds have a fixed number of shares. These shares once bought can be traded in the
secondary market (stock exchange) at the market rate. The market rate is announced daily by the
stock exchange.
The performance of mutual funds is an important factor to investors. Mutual funds basically give
rewards in two ways dividends and through capital gains. The net asset value (NAV) is the per
unit cost of acquiring a mutual fund the NAV can help determine the performance of a mutual
fund. The net asset value (NAV) is the value at which the mutual funds are bought or sold in the
market. Researchers in the past have evaluated the performance of mutual funds based on their
net asset value (NAV) considering the stock market
as the benchmark. The Mutual funds

have better returns than the stock market returns. The study by Dr. R. Navayanasany and
V.Rathnamai scholars from India conducted a research on performance evaluation of mutual fund
of India. In their research they evaluated the performance of certain mutual funds keeping the
stock market as the benchmark. The results showed that mutual funds generally outperformance
the stock market. This means that NAV values are clear indicators of a funds performance.
Further they examined the returns of certain mutual fund for this purpose they employed Sharpe
ratio, Jenson Differential and Treynor measure. The work of Jenson Michal (1967), Treynor
(1965) and Shape (1966) have proposed different methods of evaluating the performance of
mutual funds. These instrument help identify the risks and returns of a mutual fund. In another
study by Theodore Prince and Frank Bacon on performance evaluation of mutual funds have
analyzed the performance of mutual funds against the stock market as a benchmark. The
performance of mutual funds is import to both the investor and fund manager. It can be considers
as the main attraction to investor. A number of studies have been conducted on performance
evaluation of mutual funds it is most determinant that determines whether investing in a mutual
fund is good or bad.

The Pakistani mutual fund industry has seen phenomenal growth during period under study form
2009 to 2013 there has been a significant increase in the total NAV from PKR 153,066 million to
PKR 332,702 million. The industry is still small as compared to the international markets.
According to Khorana (2005) Pakistans mutual fund industry is relatively small as compared to
the international industries from India, Malaysia, Hong Kong and South Korea. The study
suggests that paid-up capital may look substantial but the size is still small as compared to the
international market.
The present study is a short study on the performance evaluation of mutual funds of Pakistan. In
this study two mutual funds from JS investments. JS Income Fund and JS Growth Fund are two
funds that will be examined to determine the performance evaluation of mutual funds. The funds
under consideration are open-ended equity funds. The reason for using an open-ended fund is
that an open-ended fund cannot be traded in the secondary market this eliminates the bias of
market information on the prices of the funds. Also for the investing purpose the results will
show more transparency. These funds are equity funds an equity fund usually has investments in
equities. An equity scheme promises capital appreciation over the long-run. The equity schemes
offer potentially the best possible returns among other mutual fund schemes. But the risk of these
investment schemes is relatively higher. The amount of risk is reduced by diversification by
investing in different types of shares. Equity funds are usually cheaper than others. In this
research the selected mutual funds will be examined to determine their performance based on the
risk and returns associated with a mutual fund. The mutual funds will be evaluated against the
stock market
KESC 100 index as the benchmark. This evaluation will help us examine

or identify the security

market returns with funds returns. Similar method was opted by

Dr. R.Navayamay and V.Rathamani in their study on mutual funds.


The efficient market theory in the context of mutual funds suggests that mutual funds should not
be able to produce consistent results and an actively managed portfolio should increase the
portfolio returns. (Talha Afza and Ali Rauf, 2009). The active management is a portfolio
management strategy in which managers specific investment goal is to outperform a specific
benchmark. The present study will further try to test the efficient market theory that whether the
mutual fund produce consistent results. And then test the active management portfolio theory that
if the mutual funds have outperformed the set benchmark or not. In our case the benchmark is the
stock market (KESC 100 index).
Further the study will evaluated the returns and risks of mutual funds to determine their
performance. Three models the Jenson Differential, Sharpe Ratio and Treynor measure are
models that help evaluate the performance of mutual funds based on the returns and risks
associated with the fund. Jenson Michal in 1976 proposed the Jenson differential model, treynor
in 1965 presented a model for the performance evaluation of mutual funds and Sharpe ratio
developed in 1966 all help evaluate the performance of mutual funds based on their risks and
returns. This model will be used in the study to examine the risks and returns of the selected

mutual funds. The relationship between risk and return determine the performance of the mutual
fund. A risk is always associated with returns maximum returns alongside acceptable risk helps
determine whether the fund performed well or not. This is what we are trying to determine
through this research.
The research will further try to test the efficient market theory. The efficient market theory
mainly deals with two issues when considering mutual funds. One whether the mutual managers
are able to produce consistent results and another is that active portfolio management increases
the portfolios returns. Active management is a portfolio management strategy where a managers
specific investment goal is to outperform a specific benchmark in our case the benchmark is
stocks
from KESC 100 index. The following research will try to test the theory whether

mutual funds are able to produce consistent results or not and if the portfolios under
consideration have been able to outperformed the set benchmark.

1. Literature review:-

National and international researches have shown keen interest in the study of mutual funds
. There are a variety of studies present on mutual funds and the industry. Broadly the

researchers conducted on mutual funds pertain to the growth analysis, risk analysis and
performance evaluation of mutual funds. These researches are of interest to investors and asset
management companies since they depict certain behaviors of the funds. Among areas of study
concerning mutual funds, performance evaluation studies are most important. The financial
performance of a fund tells investors as to what returns a mutual fund generates along with the
associated risks. The performance evaluating of the mutual funds provides an opportunity to
access the performance of the fund as to what percentage returns can be realized and what are the
risks.

The major research done in the area of performance evaluation is the development of the Sharpe
ratio
, Jensen differential and Trey nor measure. These three models were developed so

as the performance of mutual funds

can be judged. The work of William F. Sharpe

(1960) was on the portfolio theory. He introduced the concept of risk and return trade-off.
Through his model the investors can know the required rate of return of an asset. This model of
risk and return trade-off is called Sharpe ratio. Through this model one can use historical returns
of the funds, the risk-free rate and standard deviation to measure the portfolios performance.
This model helps investors decide in which portfolio to invest. Trey nors model (1965) is used
to measure the performance of a portfolio in respect to return per unit of risk. Here the risk
measure is Beta. The ratio measures the historical performance of the portfolio in terms of
return per unit of risk. Jenson in 1969 introduced a model known as Jenson Differential model.
This model helps us assess the difference between actual portfolio returns and the return that
should have been earned- known as the abnormal return of the portfolio. The work of these three
researchers is very important as they have develop methods to evaluate the performance of
mutual fund with the help of these investors can choose which a better investment option.
Another medium to judge the performance of a mutual fund is by correlation analysis. The
mutual funds are compared to a benchmark- in most cases the KSE 100 index. With the help of
this we can identify if the mutual funds returns are better than the returns of the stock

form the KSE 100 index. ( Shah and Hijazi, Performance Evaluation, 2005)

The efficient market theory has some hypothesis considering mutual funds

. The efficient

market theory in terms of mutual funds basically suggest that mutual funds should be able to
produce consistent results and that a passive management strategy is better than an active
management strategy. But further it suggests that by employing
an active management

strategy one can beat the market benchmark. This research will test the efficient market theory
and try to find that do mutual funds produce consistent results and whether the active
management strategy is true that are the mutual funds able to beat the market benchmark.
Researchers conducted in the past suggest that the mentioned models are best to describe the
performance of a mutual fund. In a research conducted by (S.M Aamir and Syed Tahir Hijazi) on
performance evaluation of mutual funds the researchers have used the Sharpe ratio, Treynor
measure and Jenson differential for the performance evaluation of mutual funds. The findings of
the research were that mutual funds usually outperform the market benchmark (e.g. KESC 100
index). Upon evaluation of the risk of mutual funds the researchers highlighted that mutual
defensive that is they have low risk characteristics.
Another research paper on mutual funds (Dr. Marayansany and V.Rathnormani) suggests that the
Sharpe ratio, Treynor ratio and Jenson differential are models that best describe a mutual funds
behavior. The researchers have used the models to identify performance of mutual funds. The
objective of the research was to examine the returns of certain mutual funds to know whether the

mutual funds are able to provide rewards with risks. The research also compared the performance
evaluation of mutual funds with the benchmark (KESC 100 index).
In the research paper

on analyzing Mutual Fund

Performance against

Established Performance Benchmark the efficient market theory is tested. The theory that the
active management strategy can increase the portfolio returns significantly. The results of the
study tend to support the efficient market theory that actively managed funds produce returns
that are in relation to the hypothesis. (Paper by, Theodore Prince, Frank Bacon)
The literature on mutual funds

is significant evidence that researchers use the mentioned

models to identify the performance of mutual funds. Hence this research will also use the same
methods. Our research will examine the performance of open-ended equity funds to examine the
returns of these funds. The risks associated with the mutual funds. Is the investment worthwhile
and compare the returns of the mutual funds with the market.

1. Methodology:-

Variable and Sources of Data

:-

The following research is on the performance evaluation of mutual funds. Two mutual funds of
JS investment JS Growth fund and JS Value Funds have been selected for this research. Both of
these funds are open-ended Equity funds. The data collected for this research are the mutual fund
returns and NAV values for a five year period from 2009 to 2014. The mutual fund data was
collected from MUFAP. The data of KESC 30 index because the company considers the KESC
30 index as the benchmark and 6 month Treasury bill returns were collected from the Security
Exchange Commission of Pakistan (SECP). The variables under consideration are the

six month Treasury bill, KESC 30 index earning per Share (EPS), net asset value (NAV),
Number of certificates outstanding and NAV per certificate.

To evaluate the performance evaluation of mutual funds in the following research three models
are being considered (1) Sharpe ratio
presented by William F. Sharpe (1960) (2) Trey

nor measure presented by Trey nor 1965 and Jensen Differential presented by Jensen Michal
(1969). Further in the analysis there will be a comparison of the mutual funds and its benchmark
the KESC 30 index. The research is incorporating data for the years 2009 to 2014. To identify
which of the two provides better returns. Further in the study we will also test the hypothesis of
the efficient market theory.

The Sharpe Ratio

The Sharpe ratio

:-

was introduced in 1960 by William F. Sharpe. The model is a ratio

of the difference between funds average return and the risk-free return divided by the

standard deviation of the fund. The model helps identify which portfolio offers the most
favorable risk/returns. Based on the ratios the funds with the highest ratio will then be selected
for investment. To compute
this ratio we will be using data of historical return of the

fund. The six month treasury bill return and standard deviation of the fund return.

Sharpe ratio

= Rp Rf

Rp = the observed average fund return;


Rf = the average risk free return;
p = the standard deviation of fund returns

Jensen differential model:-

The Jenson differential model was introduced in 1969. The differential is alpha () that is the
difference between actual average return earned by the portfolio and the return that should have
been earned by the portfolio given the market conditions and the risk of the portfolio. The funds
returns should be higher than the risk free rate of return. A positive alpha is the indicator that the
fund has outperformed the market proxy. To calculate the Jensen differential we will be using the
six month Treasury bill, the historical returns of the portfolio, the returns on the market index and
Beta of the portfolio.

Jensen measure is calculated as follows:

p = Rp [ Rf + p (Rm Rf)]

Rp = the observed returns of the portfolio


Rf = the risk free returns.

Rm = the return on the market index.


= Beta of the Protfolio.
= parameter of the model.

Try nor Measure :-

Trey nor model was introduced in (1965). The model consists of two types risks systematic and
unsystematic risk. Systematic risk is the risk which cannot be diversified. This risk is the beta of
the portfolio. A portfolio return depends on the beta. The systematic risk is uncertainty attached
with specific company and can be diversified. The mutual fund
with higher return per

unit of risk will be preferred for investment purpose than ones with the lower values. The model
measures the mangers ability to produce returns taking into account the systematic risk of the
portfolio. For trey nor measure we will use the historical returns of the funds, the six month
treasury bill returns and Beta of the portfolio.

Treynor Ratio =

(Rp Rf )

Rp = the observed average fund return.


Rf = the average risk free return.
= coefficient as a measure of systematic risk.

1. Data Analysis

The funds selected for this research are separately analyzed. Monthly data of the funds returns
were analyzed and with the help of that we calculated the yearly data. Sharpe Ratio, Trey nor
Measure and Jensen Differential were calculated on the basis of yearly data.

JS Growth Fund

The JS growth Funds average return for the five year period from 2009 to 2013 is 11.776%. The
Beta value of the fund is 0.8, the funds standard deviation is 24.7%. The six month Treasury bill
return is 9.99%.

JS Value Fund

The average return of JS Value fund for the five year period from 2009 to 2013 was 8.712. The
funds standard deviation is 21.4% and the funds beta is 0.6. The six month Treasury bill rate was
is 9.99%.\
1. Findings:

JS GF has a Sharpe ratio

of 0.0723 the Sharpe ratio is positive this means that

the fund is well diversified. Similarly the Sharpe ratio of JS VF is -0.064 this is a
negative figure which means that the portfolio was not diversify. The reason can be the
fund managers inability to diversify.

However we have considered a small sample that is the reason why the value of the
Sharpe ratio is small.

Jensen Differential is a medium to judge whether a fund has been able to bet the
benchmark. A positive alpha () means that the fund is less volatile to the benchmark.
And a negative alpha () means that the fund is more volatile than the benchmark. JS GF
has a +ve lpha and JS VF has a ve lpha. JS GF is less volatile and JS VF is more
volatile than the benchmark.

The trey nor measure is a measure that the fund with a higher T-ratio is a better
investment option. T

R Square : 70 100% means good correlation between fund and benchmark returns.

: 40 70% means average correlation between fund and benchmark returns.


: 1 40%

means low correlation between fund and benchmark returns.

R- Square for JS GF and JS VF is 71.5% and 48.6%. This means that there is a good and
average correlation between the funds alongside the benchmark returns.

This means that a correlation exists.

The graphical representation on graphs 1 and 2 show that the funds return are higher than
the returns of the KSE 30 index the benchmark for these funds. This means that the funds
have been able to perform better than the market. This means that the funds were well
diversified.

It is feasible for investors to invest in mutual funds

better results and are well diversified.

since mutual funds provide

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