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EVALUATION OF RISK-ADJUSTED PERFORMANCE OF MUTUAL FUNDS IN INDIA

Dr. Sandeep Bansal* Sanjeev Kumar**

ABSTRACT
In this paper an attempt has been made to study the performance of selected mutual funds schemes based on risk-return relationship models, and return on mutual funds are also compared with return on equity shares of different sectors of Indian economy. Return on ten mutual funds schemes and return on equity shares of three sectors namely Fast Moving Capital Goods, Information Technology and Power sectors have been studied over the time period Jan. 2006 to Jan 2009 (3 years). The analysis has been made on the basis of mean return, intercept, beta, Sharpe ratio, Treynor ratio, and Jensen Alpha. The overall Analysis finds UTI schemes being best performers and others showing below average performance. Ke words: Investor, Risk, Return, Mutual Fund, Beta, Sharpe Ratio, Treynor Ratio.

*Assistant Professor, Indira Gandhi National College, Ladwa, Kurukshetra **Faculty of Management, Emax Business School, Ambala International Journal of Research in Economics & Social Sciences http://www.euroasiapub.org

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INTRODUCTION
Mutual Fund Is a fund, managed by an investment company with the financial objective of generating high Rate of Returns. Or An investment vehicle managed by finance professionals that raises capital by selling shares (called units) in a chosen and balanced set of securities to the public. A mutual fund is a type of investment fund. An investment fund is a collection of investments, such as stocks, bonds or other funds. Unlike most other types of investment funds, mutual funds are open-ended, which means as more people invest, the fund issues new units or shares. A mutual fund typically focuses on specific types of investments. For example, a fund may invest mainly in government bonds, stocks from large companies or stocks from certain countries. Some funds may invest in a mix of stocks and bonds, or other mutual funds. These asset management or investment management companies collects money from the investors and invests those money in different Stocks, Bonds and other financial securities in a diversified manner. Before investing they carry out thorough research and detailed analysis on the market conditions and market trends of stock and bond prices. These things help the fund managers to speculate properly in the right direction. The investors, who invest their money in the Mutual fund of any Investment Management Company, receive an Equity Position in that particular mutual fund. When after certain period of time, whether long term or short term, the investors sell the Shares of the Mutual Fund, they receive the return according to the market conditions. The investment companies receive profit by allocating people's money in different stocks and bonds according to their Speculation about the Market Trend. Other than some specific mutual funds which carry certain Maturity Term, Investors can generally sell the shares of their mutual funds at any time they want. But, the return will vary according to market value of the stocks and bonds in which that particular mutual fund made investment. But, generally the share holders of mutual fund sell their share when the prices are up and Capital Gain is sure to happen. A mutual fund's capital is invested in a group (portfolio) of corporate securities, commodities, options, etc., that match the fund's objectives detailed in its prospectus. The level of a mutual fund's income from its portfolio determines the daily market value (called net asset value) at which its units are redeemable on any business day, and the dividend paid to its unit holders.

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TYPES OF MUTUAL FUNDS SCHEME IN INDIA

Wide variety of Mutual Fund Schemes exists to cater to the needs such as financial position, risk tolerance and return expectations etc. The table below gives an overview into the existing types of schemes in the Industry. By Structure Open - Ended Schemes Close - Ended Schemes Interval Schemes Growth Schemes Income Schemes Balanced Schemes Money Market Schemes

By Investment Objective

Other Schemes Tax Saving Schemes Special Schemes o Index Schemes o Sector Specific Schemes Close Ended Fund/ Scheme: A close-ended fund or scheme has a stipulated maturity period eg. 5-7 years. The fund is open for subscription only during a specified period at the time of launch of the scheme. Investors can invest in the scheme at the time of the initial public issue and thereafter they can buy or sell the units of the scheme on the stock exchanges where the units are listed. In order to provide an exit route to the investors, some close-ended funds give an option of selling back the units to the mutual fund through periodic repurchase at NAV related prices or they are listed in secondary market. Open Ended Fund/ Scheme: An open-ended mutual fund is the most common type of mutual fund available for investment. An investor can choose to invest or transact in these schemes when ever he likes to. In an openended mutual fund, there is no limit to the number of investors, shares, or overall size of the International Journal of Research in Economics & Social Sciences http://www.euroasiapub.org

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fund, unless the fund manager decides to close the fund to new investors in order to keep it manageable. The value or share price of an open-ended mutual fund is determined at the market close every day and is called the Net Asset Value (NAV). Interval Schemes: Interval Schemes are that scheme, which combines the features of open-ended and close-ended schemes. The units may be traded on the stock exchange or may be open for sale or redemption during pre-determined intervals at NAV related prices. FMP or the Fixed Maturity Plans are the example for these types of schemes. Equity mutual funds: These funds invest a maximum part of their corpus into equities holdings. The structure of the fund may vary different for different schemes and the fund managers outlook on different stocks. The Equity Funds are sub-classified depending upon their investment objective, as follows:

Diversified Equity Funds Mid-Cap Funds Small Cap Funds Sector Specific Funds Tax Savings Funds (ELSS)

Equity investments are meant for a longer time horizon, thus Equity funds rank high on the riskreturn matrix. Debt mutual funds: The objective of these Funds is to invest in debt papers. Government authorities, private companies, banks and financial institutions are some of the major issuers of debt papers. By investing in debt instruments, these funds ensure low risk and provide stable income to the investors. Debt funds are further classified as:

Gilt Funds Income Funds MIPs Short Term Plans Liquid Funds International Journal of Research in Economics & Social Sciences http://www.euroasiapub.org

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Balanced funds: As the name suggest they, are a mix of both equity and debt funds. They invest in both equities and fixed income securities, which are in line with pre-defined investment objective of the scheme. These schemes aim to provide investors with the best of both the worlds. Equity part provides growth and the debt part provides stability in returns. BY INVESTMENT OBJECTIVE Growth Schemes Growth Schemes are also known as equity schemes. The aim of these schemes is to provide capital appreciation over medium to long term. These schemes normally invest a major part of their fund in equities and are willing to bear short-term decline in value for possible future appreciation. Income Schemes Income Schemes are also known as debt schemes. The aim of these schemes is to provide regular and steady income to investors. These schemes generally invest in fixed income securities such as bonds and corporate debentures. Capital appreciation in such schemes may be limited. Index Schemes Index schemes attempt to replicate the performance of a particular index such as the BSE Sensex or the NSE 50. The portfolio of these schemes will consist of only those stocks that constitute the index. The percentage of each stock to the total holding will be identical to the stocks index weight age. And hence, the returns from such schemes would be more or less equivalent to those of the Index.

REVIEW OF LITERATURE
In this paper, an attempt has been made to study the performance of selected schemes of mutual funds based on risk-return relationship. For this purpose, apart from standard measure like mean return, beta and coefficient of determination, the time-tested models of mutual funds performance evaluation given by Sharpe, Treynors and Jensen have also been applied. Zakri Y.Bello (2005) studied a sample of socially responsible stock mutual funds with randomly selected conventional funds of similar net assets to investigate differences in characteristics of assets held, degree of portfolio diversification and variable effects of diversification on investment performance. The study found that socially responsible funds do not differ significantly from conventional funds in terms of any of these attributes. Moreover, the effect International Journal of Research in Economics & Social Sciences http://www.euroasiapub.org

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of diversification on investment performance is not different between the two groups. Both groups underperformed the Domini 400 Social Index and S & P 500 during the study period. Dimitri Margaritis, Roger Otten and Alireza Tourani-Rad (2007) apply data envelopment (DEA), a mathematical programming technique, to measure the performance of equity retail funds in New Zealand over the period 19982003. An analysis of fifty-two equity mutual funds, national and international, shows significant differences in their performances, with an average DEA efficiency score of 0.72. The application of regression analysis further shows that funds with an international asset allocation strategy have had lower efficiency scores, and that larger funds have had higher efficiency scores. Ken L. Bechmann and Jesper Rangvid (2007) examine Danish mutual funds. The authors describe what is special about Danish mutual funds, as well as the dimensions along which Danish funds are comparable to other European funds. They discuss how Danish mutual funds have performed in absolute terms and in relation to other European mutual funds, and focus also on the costs to the investor of purchasing Danish mutual funds certificates. Finally, the authors compare Danish fund costs with the mutual fund costs in other European countries. Roberto Savona (2007) discusses the recent evidence suggesting that behind investment strategies there is a latent philosophy featuring the market in which money managers operate. Starting from this insight, the study explores the styles and performance of Italian managers over the period 19992004, making as clear as possible all the significant idiosyncrasies the authors find by scrutinizing the return patterns over time. Javier Gil-Bazo and Pablo Ruiz-Verd (2007) study investigates the relationship between fees and performance in the US market for domestic equity mutual funds. The analysis shows that price and quality have been related negatively in this market during the period 19922003. The result holds for different measures of performance, across fund categories, and across time periods, with a single exception: the dot-com bubble, when more expensive funds delivered higher-than-average abnormal returns. Wolfgang Breuer and Marc Grtler (2007) study examines a set of performance measures derived for the general case of mean-risk-preferences based on a portfolio-theoretical framework. As an application of general analysis, the authors use Yaaris dual theory of choice to develop a specific measure of dual risk, which leads to the consideration of generalized Gini International Journal of Research in Economics & Social Sciences http://www.euroasiapub.org

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mean differences. The authors contrast the resulting performance measures with performance evaluations in the case of traditional mean-variance and mean-variance-skewness analysis via an empirical study of the German capital market. Valerio Pot and Eoghan Duffy (2007) study analyzes the persistence of Irish mutual funds using a contingency table methodology. The authors find little evidence of performance, but discover that risk adjustments are important in evaluating performance. Radu Burlacu, Isabelle Girerd-Potin and Denis Dupr (2007) study investigates whether it is possible to reconcile ethical and financial performance. Using a new measure of ethical strength, the authors find that US equity mutual funds exhibit a highly significant negative relation between the two, suggesting the existence of ethical costs. Ethical funds seem able, nevertheless, to compensate ethical costs with superior financial performance. Ethanou (2008) study examines the risk adjusted overall performance of 17 Greek Equity Mutual Funds between the years 1997 and 2005. The results indicate that the majority of the funds under examination followed closely the market, achieved overall satisfactory diversification and some consistently outperformed the market, while the results in market timing are mixed, with most funds displaying negative market timing capabilities. Sharad Panwar and Dr. R. Madhumathi (2009) study used sample of public-sector sponsored & private-sector sponsored mutual funds of varied net assets to investigate the differences in characteristics of assets held, portfolio diversification, and variable effects of diversification on investment performance for the period from May, 2002 to May,2005. The study found that public-sector sponsored funds do not differ significantly from private-sector sponsored funds in terms of mean returns. However, there is a significant difference between public-sector sponsored mutual funds and private-sector sponsored mutual funds in terms of average standard deviation, average variance and average coefficient of variation(COV). The study also found that there is a statistical difference between sponsorship classes in terms of ESDAR(excess standard deviation adjusted returns) as a performance measure. When residual variance (RV) is used as the measure of mutual fund portfolio diversification characteristic, there is a statistical difference between public-sector sponsored mutual funds and private-sector sponsored mutual funds for the study period. The model built on testing the impact of diversification on fund performance and found a statistical difference among sponsorship classes when residual International Journal of Research in Economics & Social Sciences http://www.euroasiapub.org

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variance is used as a measure of portfolio diversification and excess standard deviation adjusted returns as a performance measure. RV, however, has a direct impact on Sharpe fund performance measure.

OBJECTIVES OF THE STUDY

The specific objectives of the study are: i) ii) Evaluate the performances of selected Mutual Funds on the basis of risk adjusted measures like Sharpe Model, Treynors Model and Jensen model. Compare the returns of selected Mutual funds with the return on equity shares of three different sectors of Indian economy and market portfolio returns.

RESEARCH METHODOLOGY
As many researchers conducted to evaluate the performance of the mutual funds have proved that this is a matter of concern for the researcher, academicians, fund managers and financial analysts. These researches are the matter of criticism on the various grounds such as number of samples, time period of the research or the selection of a particular scheme. This study is an effort of its own kind to contribute to this field and may open up avenues for further intensive research on its different related aspects of portfolio management practices. The study is entirely based on the secondary data. The scope of the study is kept limited to the time period of 3 years (Jan 2006 to Jan 2009). The sample consists of 10 mutual fund schemes and 3 sectors, which are chosen at random basis. It is important to point out that NAVs have been taken on monthly basis. The data regarding the NAVs and return of these 10 mutual fund schemes have been noted from SEBI annual reports, prowess database and www.amfiindia.com. The BSE Sensex was used as the proxy for market index and each scheme has been evaluated with respect to this benchmark. The portfolio return calculated on the basis of NAV does not consider any change in the market price but considers the change in the net asset value of mutual funds units and specific sectors during the period. Portfolios return (Rn) is calculated by using the following formula:

RP

(NAV t NAV t 1 )D t C t NAV t 1

Rp = Portfolio return International Journal of Research in Economics & Social Sciences http://www.euroasiapub.org

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NAVt= Net asset value in time period t NAVt-1 = Net asset value in the period t-l Dt = dividend in the form of bonus distributed in the period t Ct = cash dividend distributed in the time period t Month-wise returns have been calculated for all mutual funds schemes for the study period i.e. from Jan 2006 to Jan 2009. The portfolio return Rp was computed in the manner prescribed above on a monthly basis. The same procedure is adopted to calculate the benchmark portfolio return. Risk is calculated by determining the standard deviation and the formula to calculate standard deviation is

S tan dard deviation of the portfolio

(R p R p )2 n 1

Risk defines the fluctuations in the returns of a fund during a given time period. If there is a probability of high increase and decrease in the return it means more will be the fluctuation, which represents a higher level of risk. The standard deviation represents total risk associated with a security. This total risk further can be categorized in two parts 1) Systematic risk 2) Unsystematic risk. Systematic risk is that fluctuation which occurs due to the unavoidable or uncontrollable factors such as interest rate, inflation rate and other market factors. So this risk plays a more important part in evaluation of the fund performance. This is represented by beta and calculated as follows:

Cov (R p 3R M )/ 2 (R M )
If a fund NAV is more sensitive towards the market fluctuation, it means that the fund has high beta coefficient or vice-versa. On the other hand, unsystematic risk occurs due to specific securities in the portfolio and can be diversified. Beta () of a stock or portfolio is a number describing the relation of its returns with those of the financial market as a whole. An asset has a Beta of zero if its returns change independently of changes in the market's returns. A positive beta means that the asset's returns generally follow the market's returns in the sense that they both tend to be above their respective averages together, or both tend to be below their respective

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averages together. A negative beta means that the asset's returns generally move opposite the market's returns: one will tend to be above its average when the other is below its average. Alpha is a risk-adjusted measure of the so-called active return on an investment. It is the return in excess of the compensation for the risk borne, commonly used to assess active managers' performances. Often, the return of a benchmark is subtracted in order to consider relative performance which yields Jensen's alpha. The risk free rate of return is the best rate that does not involve taking a risk. Both the return of the original capital and the payment of interest are completely certain. The risk-free rate for the given period is taken 5%. It is return on government bonds during the study period. This is because a government cannot run out of its own currency, as it is able to create more as necessary. Any other investment should produce greater returns than the risk free rate. The extra return (the risk premium) reflects the extra risk. Sharpe Model In this model, performance of a fund is evaluated on the basis of Sharpe ratio, which is the ratio of returns generated by the fund over and above risk free rate of return and the total risk associated with it. According to Sharpe, it is the total risk of the fund that the investors are more concerned about. So, the model evaluates funds on the basis of reward per unit of total risk. Symbolically, it can be written as: Sp = (RP - RF)/ p SP = Sharpes index RP = Portfolio average return RF = Risk free rate of return P = Standard deviation of the return Treynors Model Developed by Jack Treynor, this performance measure evaluates funds on the basis of Treynor Index. This index is a ratio of return generated by the fund over and above the risk free rate of return (generally taken to be return on the securities backed by the government) during a given time period and systematic risk associated with it measured by Beta. This is called as reward to volatility ratio. Symbolically, it can be represented as: Treynors Index (Tp) = (Rp - RF) / P RP = Portfolio average return International Journal of Research in Economics & Social Sciences http://www.euroasiapub.org

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RF = Risk free rate of return P = Slope of the characteristic line Jensen Model Jensen model is yet another risk-adjusted performance measure. This measure is developed by Michael Jensen and sometimes referred as the differential return method. This measure involves evaluation of the returns that the fund has generated vis--vis the return actually expected of the fund given the level of its systematic risk. The difference between two returns is called alpha, which measures the performance of a fund compared with the actual return over the period. Required return of a fund at a given level of risk (13) can be calculated as: E (Rp) = RF + (RM - Rp) E(RP) = The expected return on security or portfolio RF = Risk free rate of return Beta = Systematic risk of the portfolio RM = Average market return during the period RP = Return of the portfolio

RESULTS
Return The Table 1 (see appendix) depicts the return earned by the mutual fund schemes, sectors and the return on the stock market index for the study period. Return for the individual mutual find is calculated by using NAV of the fund and return on equity shares of three sectors and the market has been calculated by using market prices of equity shares and index value (like BSE Sensex). Systematic Risk (Beta)
The Table 1 also presents the systematic risk of the 10 mutual fund schemes and 3 sectors. Beta signifies the sensitivity of the return on the mutual fund scheme in comparison to the movement in the stock market index. Beta is a measure of systematic risk. Beta value for a mutual fund scheme is calculated as the percentage change in NAV of the scheme for one percent change in the stock market index (in our case, BSE Sensex). Beta values of higher that unity imply higher portfolio risk for the schemes than the market portfolio, and vice-versa. It is observed that out of the 10 selected mutual fund schemes and 3 sectors, two schemes namely, Birla Sun Life Basic Inds. Fund (2.83),
Franklin India Blue-chip Fund (1.0286), and one Power Sector (1.262) were found to be more risky

(beta > 1.0) than the market. Remaining 8 schemes and two sectors were less risky among the lot.

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Results of Sharpe Ratio Measure

The third column of Table 2 (see appendix) depict the values of Sharpe ratio for the schemes and the market index. Sharpe ratio is the ratio of returns generated by the fund over and above risk free rate
of return (RF ) and divided by the total risk associated with it. Positive values of schemes indicate

better performance. High positive values of Sharpe ratio found in H D F C Liquid Fund (0.0106), L & T Liquid Fund (0.0102), U T I Money Market Fund (0.0014) among schemes as against the level of risk involved. Thus, the investors of these schemes have been rewarded well on their invested money. These schemes were also those which had out-performed the market index which further strengthens our above conclusion. Sharp Ratio of all the three sectors is negative. About 7 mutual fund schemes (70 percent) have failed to beat the market because Sharpe ratio has shown negative values. The worst performer is Birla Sun Life Basic Inds. Fund (negative values and/or less than market Sharpe ratio). Although the 7 schemes out of 10 mutual fund schemes had negative Sharpe values, but except the Birla Sun Life, these schemes had higher values than their corresponding values of market index for the study period, which goes to show the better performance of these schemes in a falling market.
Results of Treynors Ratio Measure

Treynors ratio measures the excess return earned over risk-free return per unit of systematic risk i.e., beta. The fourth column of Table 2 presents the Treynors ratio values for the individual mutual fund schemes, sectors and the market portfolio, respectively. Here, the major observations mirror the similar finding as in Sharpe ratio.
Results of Jensen Measure (Alpha)

The 5th column of Table 2 shows the Jensens alpha values for the 10 selected mutual funds schemes and 3 sectors. It is the regression of excess return of the scheme (dependent variable) with excess return of the market (independent variable). Higher alpha values indicate better performance. Among the public sector, higher alpha was found with Templeton India Pension Plan followed by H D F C Liquid Fund, L & T Liquid Fund and U T I Money Market Fund, while in sectors showed negative alpha values which indicates the failure on part of their funds managers to forecast security prices in time for taking better investment decisions. The overall analysis finds U T I Money Market Fund and H D F C Liquid Fund being the best performers, and Reliance Growth Fund, Morgan Stanley Growth Fund mutual funds showing poor below-average performance when measured on the basis of risk-return relationship models International Journal of Research in Economics & Social Sciences http://www.euroasiapub.org

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during the study period. The risk adjusted return on all the three sectors shown negative values for Sharpe, Treynors, and Jensen Measures. Thus, the investors of these sectors have not been rewarded well on their invested money during the study period. The small investors are well-advised to analyze the return and risk parameters of the mutual funds, over longer period of time, before their investment decisions. Although mutual finds are instruments of diversified investments, a prudent choice between the many available mutual fund schemes will go a long way in generating wealth for the investors. Further, in times of high stock market volatility, mutual funds are the best source of investments with assured and adequate returns provided the selection of the mutual funds is in the right direction. REFERENCES
Jackwerth, J., 2000, Recovering Risk Aversion from Option Prices and Realized Returns, Review of Financial Studies 13, 433-451. Jorion, P., 1995, Predicting Volatility in the Foreign Exchange Market, Journal of Finance 50, 507-528. Jorion, P., 2000, Risk Management Lessons from Long-Term Capital Management, European Fi- nancial Management 6(3), 277-300. Lewis, M., 1999, How the Eggheads Cracked, New York Times Magazine, January 24, 2477. Mitchell, M., and T. Pulvino, 2001, Characteristics of Risk in Risk Arbitrage, Journal of Finance 56, 2135-2175. Modigliani, F., and L. Modigliani, 1997, Risk-Adjusted Performance, Journal of Portfolio Manage- ment 23 (2), 45-54. Neuberger, A., 1994, The Log Contract: A New Instrument to Hedge Volatility, Journal of Portfolio Management, Winter, 74-80. Pan, J., 2002, The Jump-Risk Premia Implicit in Options: Evidence from an Integrated TimeSeries Study, Journal of Financial Economics 63, 3-50. Peskin, M., M. Urias, S. Anjilvel, and B. Boudreau, 2000, Why Hedge Funds Make Sense, Quanti- tative Strategies, Global Equity and Derivative Markets, Morgan Stanley Dean Witter. Satyha Swaroop Debashish, volume 2, issue (2) 2009, Options and Effciency, KCA Journal of Business Management.

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*Appendix Table No. 1

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S.No. Name of Security Templeton India Pension 1 Plan Franklin India Bluechip 2 Fund Morgan Stanley Growth 3 Fund Birla Sun Life Basic Inds. 4 5 6 7 Fund H D F C Liquid Fund L & T Liquid Fund L I C M F Balanced Fund F T India Monthly Income 8 9 10 11 12 13 14 Plan Reliance Growth Fund U T I Money Market Fund FMCG IT POWER BSE 30

Return

S.D.

Beta

Intercept

-0.0067

0.04806

0.3936

-0.0077

-0.006

0.0983

1.0286

-0.0086

-0.0047

0.0895

0.9971

-0.0072

-0.0877 0.0063 0.0061 -0.011

2.7212 0.001 0.001 0.082

2.839 -0.0039 -0.0059 0.7097

-0.1595 0.0063 0.0061 -0.0129

0.0008 -0.0093 0.0014 0.01 -0.0103 0.009 0.0025

0.0581 0.1006 0.0007 0.07 0.0875 0.1199 0.875

0.5869 0.9905 -0.0015 0.06 0.6174 1.262 1

-0.0006 -0.0118 0.0014 0.01 -0.0119 0.0059

Table No. 2 Risk Free S.No. Name of Security Templeton India Pension 1 2 Plan Franklin India Bluechip -0.1095 -0.2086 Sharpe Treynor 1.287348 0.1399 -0.52218 0.5 0.5 Jenson rate

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0.491931 -0.1884 0.506168 -5.6178 0.0106 0.0102 0.020701 12.65897 8.371186 -

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Morgan Stanley Growth 3 Fund Birla Sun Life Basic Inds. 4 5 6 Fund H D F C Liquid Fund L & T Liquid Fund

-0.435953

0.5

-11.87038 0.0077824 0.0038875

0.5 0.5 0.5

L I C M F Balanced Fund F T India Monthly Income

-0.186

0.720023 -

-0.36773

0.5

Plan

-0.1146

0.850571 -

-0.29405

0.5

9 10

Reliance Growth Fund U T I Money Market Fund

-0.2198 0.0014

0.514185 3.32 -

-0.50705 0.00215

0.5 0.5

11

FMCG

-0.12

8.166667 -

-0.02

0.5

12

IT

-0.1956

0.826531 -

-0.3206

0.5

13 14

POWER BSE 30

-0.2218 -1.745

0.389065 -0.4975

-0.6251 -0.5

0.5 0.5

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