Edwin B. Valeroso, PhD Associate Professorial Lecturer Graduate School of Business De La Salle University-Dasmarinas, Philippines

Transcription

1 The Risk-Adjusted Returns of Equity Mutual Funds in the Philippines By Edwin B. Valeroso, PhD Associate Professorial Lecturer Graduate School of Business De La Salle University-Dasmarinas, Philippines Abstract: This study analyzed the investment performance of equity mutual funds in the Philippines during the five-year period January 1, 2011 to December 31, 2016 using the four most commonly used risk-adjusted investment performance measures:(a) Sharpe ratio, (b) Treynor s ratio, (c) Jensen s alpha and (d) Information ratio. The study showed that a number of equity mutual funds ranking deteriorated if said ranking is based on their risk-adjusted returns. The two index tracker mutual funds included in the study were not closely tracking their chosen benchmark. All the four risk-adjusted measures supported each other as shown by the strong correlation between each paired combination of the measures. Lastly, the four measures were statistically and significantly different from each other. Key Words: mutual funds; risk-adjusted returns; investment performance; 1. BACKGROUND OF THE STUDY Some investors are by nature risk-averse when it comes to investing their money. For them, the return on investment is not the only consideration when they invest andthe amount of risks involved in any investment proposition is also an important factor that they consider. When they talk about returns, these people are interested in the risk-adjusted returns of their investment. Thisdoes not hold trueonly for stock and bonds but alsofor mutual funds. In the Philippines, an increasing number of people are becoming more aware of this investment instruments called mutual funds and an increasing number of Filipinos has been investing in this investment instrument. As of December 31, 2016, the total investment in mutual funds wasover Php242 billion. Among the different categories of mutual funds, the ones belonging to equity mutual funds category are considered to be the most aggressive. It is therefore possible that some investors could be misled to invest in equity mutual funds that assume higher risks that are not within their risk preferences.for example, retired employees or those nearing their retirement, in general, should not be taking risks more than what their younger counterparts do. Every year, the Philippine Investment Funds Association (PIFA), the trade association of mutual funds in the country, publishes the performance of all equity mutual funds and gives awards tothose funds that garnered the highest returns which are not adjusted for risks. In an earlier study of Almonte (2013) on Philippine equity mutual funds, she used Sharpe ratios, Treynor s ratios and Jensen s alphas to compare the funds risk-adjusted performance during the period Many changes hadhappened since that study was made in terms of the Philippine economy, geo-political 200

2 situation, regulatory environment and the changes in the composition of the thirty-stock Philippine stock exchange index (PSEi). This study used a longer period and more recent data which runs from January 1, 2011 to December 31, Aside from the three measures utilized by Almonte (2013), this paper added a fourth risk-adjusted measure called Information Ratio. This ratio takes into account the ability of portfolio managers in asset allocation and investment timing, among other things. This paper also looked into the performance of two index mutual funds vis-à-vis the performance of the benchmark that they to track. Lastly, this study tested the correlation and the existence of statistical difference between two-paired risk-adjusted performance measures. 2. OBJECTIVES OF THE STUDY The objectives of this paper are: (1) to demonstrate that there are changes in the performance ranking of equity mutual funds on a risk-adjusted performance basis; (2) to examine the ability of the equity portfolio or fund managersin terms of asset allocation and investment timing using information ratios; (3) to check if there are significant statistical differencesand correlation between pairs of risk-adjusted measures; and (4) to get the overall rank of each equity fund by combining the four risk-adjusted measures together. 3. DATA USED Monthly fivedata from January 2011 to December 2016 were used in this study. The six equity mutual funds with less than five years in existence were not included in the study. They are: One Wealthy Nation Fund, ATRAM Alpha Opportunity Fund, PAMI Equity Index Fund, Philequity Dividend Yield Fund, Soldivo Strategic Growth Fund, Sun Life Prosperity Philippine Stock Index Fund, and First Metro Philippine Equity Exchange Traded Fund. The nine mutual funds included in this study arefirst Metro Save and Learn Equity Fund, ALFM Growth Fund, ATRAM Philippine Equity Opportunity Fund, Philam Strategic Growth Fund, Philequity Fund, Philequity PSE Index Fund, Philippine Stock Index Fund, Sun Life Prosperity Philippine Equity Fund and United Fund. Philequity PSE Index Fund and Philippine Stock Index Fund are index funds whose objective is to mimic and replicate the performance of the Philippine Stock Exchange Index (PSEi). From the daily net asset value per share (NAVPS) of the nine equity mutual funds, the monthly returns were computed as: Monthly mutual fund return = 100* (NAVPS t NAVPS t-1 ) / NAVPS t-1 where NAVPS t is the net asset value per share at time t of the mutual fund and NAVPS t-1 is the net asset value per share at time t-1 The monthly returns of the 91-day treasury bills published in the BSP website were chosen to represent the risk-free rates of return.the stock market performance is represented by the Philippine Stock Exchange Index (PSEi). The monthly PSEi returns were computed as follows: PSEi monthly market return = 100* (PSEI t PSEI t-1 ) / PSEI t-1 where PSEI t is the Philippine Stock Exchange index value at the close of day tand PSEI t-1 is the Philippine Stock Exchange index value at the close of day t-1 201

3 4. METHODOLOGY This study utilized the followingfour most commonly and widely used risk-adjusted measures of performance of investment portfolios: 1. Sharpe Ratio(S p ): S p = (R p -R f )/δ p,where R p is the portfolio return which corresponds to the mutual fund return in this study; R f is the risk free rate of return; and δ p is the standard deviation of the portfolio return which represents the risk attributable to the unsystematic risk where the portfolio is exposed. In 1966, Dr. William Sharpe (Sharpe, 1966) developed a measure of investment portfolio performance discounted for unsystematic risks called Sharpe ratio. Unsystematic risks are attributable to the risks innate to the stocks. These risks can be reduced through portfolio diversification by increasing the number of stocks in the portfolio and by combing stocks that are not significantly and positively correlated with each other. This is one fundamental principle under the Modern Portfolio Theory developed by Markowitz (1952). 2. Treynor s Ratio:T p = (R p -R f )/β p, where R p is the portfolio return which corresponds to the mutual fund return in this study; R f is the risk free rate of return; and β p is the systematic risk the portfolio is exposed; the amount of risk assumed by the portfolio in relation to the market risk. Treynor (1965a) came up with a performance measure adjusting the portfolio performance for market risk as measured by the beta (β) of the stock. The market risk is a systematic risk which cannot be reduced by portfolio diversification. 3. Jensen s alpha:α p = R p - R f -β p ( R m R f ), wherer p is the portfolio return corresponding to the mutual fund return in this study; R f is the risk free rate of return; β p is the systematic risk the portfolio is exposed to; the amount of risk assumed by the portfolio in relation to the market risk; and R m is the market return Jensen (1968) introduced a more stringent measure of risk-adjusted return by introducing an alpha value which is the excess of the portfolio return over the portfolio s required rate of return. The portfolio required rate of return is based on the capital asset pricing model developed by Markowitz (1952). The value of the alpha is computed by using an ordinary least squares regression. Jensen s alpha corresponds to the computed intercept of the regression line α p + β p ( R m R f )= R p - R f. 4. Information Ratio: IR = [E(R p )-E(R b )] / δ(r p -R b ) = α p /TE, wheree(r p ) is the expected return of the portfolio; E(R b ) is the expected return of the benchmark or market portfolio which is the PSEi in this study; δ(r p -R b ) is the standard deviation of the excess return of the portfolio over the market portfolio; this is called the tracking error (TE); and α p is the expected excess return of the portfolio over the benchmark return which is the PSEi in this study 202

4 The information ratio (IR) is a measure of aportfolio manager s performance considering risks and return vis-à-vis a benchmarkthat the portfolio manager tries to outperform, Blatt (2004). It is a more stringent measure because it measures the excess portfolio return with reference to the portfolio s tracking error. IR also indicates the portfolio manager s ability to do asset allocation and investment timing. The overall rank of each equity mutual fund is obtained by adding thefund s rank under each of the four riskadjust performance measures. The best performing equity mutual fund on a risk-adjusted basis is the one with the smallest sum as inspired by Badillo et al. (2003) and as cited by Almonte (2013) in her study. 5. DATA ANALYSIS AND FINDINGS The equity mutual fund with the highest average monthly return is Philippine Stock Index Fund while the one with the lowest average monthly return is United Fund. On an annual basis, the fund with the highest average return is Philequity PSE Index Fund while the one with the lowest average annual return is again United Fund. Please see Table 1. Table 1: Average monthly and annual return, Standard Deviation and Beta of Equity mutual Funds Rank Average Rank Ave. Average Ave. Mutual Funds Monthly Monthly Annual Annual Return Return Return Return Standard Deviation Rank of Standard Deviation As far as volatility of returns (as measured by standard deviation)is concerned, the fund that is least volatile is Philequity PSE Index Fund while the most volatile is ALFM Growth Fund. Beta is a measure of volatility or risk in relation to the benchmark stock market which is represented by PSEi in this study. Based on the above Table 1, the least risky in terms of beta is ALFM Growth Fund which is about 12% less volatile than the PSEi. On the other hand, the riskiest fund based on beta is Philequity PSE Index Fund with a beta of or around 10.4% riskier than the market. The average beta of the nine equity mutual funds under study is 1.01, which is not bad at all. Although Philequity PSE Index Fund exhibited the highest average annual return for the past five years, it assumed the highest level of risks as measured by both the standard deviation and beta of its returns. Except for ALFM Growth Fund and Philippine Stock Index Fund, the other seven equity mutual funds have a beta Beta Rank based on Beta 1 First Metro Save and Learn Equity Fund ALFM Growth Fund ATRAM Philippine Equity Opportunity Fund Philam Strategic Growth Fund Philequity Fund Philequity PSE Index Fund* Philippine Stock Index Fund * Sun Life Prosperity Philippine Equity Fund United Fund PSEi Day Tbills per annum (RFR) (1.862) Average (Mutual Funds) * Index tracker mutual funds 203

5 greater than one (1.00) which means that they are more volatile than the market. On the contrary, these two mutual funds are the riskiest in terms of the volatility or standard deviation of their returns. Table 2: The Information Ratios and Tracking Errors of Equity Mutual Funds Mutual Funds Average Excess Return Standard Deviation of Excess Return Information Ratio Annualized IR Annual Tracking Error 1 First Metro Save and Learn Equity Fund (0.232) (0.128) (0.44) ALFM Growth Fund (0.330) (0.174) (0.60) ATRAM Philippine Equity Opportunity Fund (0.254) (0.152) (0.53) Philam Strategic Growth Fund (0.329) (0.274) (0.95) Philequity Fund Philequity PSE Index Fund* Philippine Stock Index Fund * Sun Life Prosperity Philippine Equity Fund (0.191) (0.211) (0.73) United Fund (0.590) (0.369) (1.28) 5.54 Philippine PSE Index Fund and Philippine Stock Index Funds are two mutual funds whose objective is to track the performance of the PSEi. As shown in Table 2, they are not accurately tracking the PSEi with 2.58% and 2.77% tracking error, respectively. Table 3: The Sharpe Ratio, Treynor s Ratio, Jensen s Alpha and Information Ratio of Equity Mutual Funds Sharpe Jensen's Sharpe Treynor's Treynor's Jensen's Information Overall Mutual Fund Ratio Alpha Information Total Ratio Ratio Ratio alpha Ratio Ranking Ranking Ranking Ratio Ranking Ranking 1 First Metro Save and Learn Equity Fund (0.115) 4 (0.442) ALFM Growth Fund (0.298) 8 (0.602) ATRAM Philippine Equity Opportunity Fund (0.158) 6 (0.528) Philam Strategic Growth Fund (0.274) 7 (0.950) Philequity Fund Philequity PSE Index Fund* Philippine Stock Index Fund * Sun Life Prosperity Philippine Equity Fund (0.137) 5 (0.730) United Fund (0.484) 9 (1.278) PSEi Funds ranking per risk-adjusted measure and their overall ranking Looking at the Sharpe ratios, Philequity PSE Index Fund is the best performing fund with the highest Sharpe ratio of Together with Philequity Fund and Philippine Stock Index Fund, Philequity PSE Index Fund beat the PSEi whose Sharpe ratio is Philequity PSE Index Fund s excess return over the risk free rate is of its standard deviation which is the lowest at On the other hand, the worst performing Fund is United Fund with a Sharpe ratio of

6 Based on Treynor s ratios, which measures risks in terms of market risks, Philippine Stock Index Fund is the best performing Fund, followed by Philequity Fund then Philequity PSE Index Fund. The worst performer is again United Fund followed by Philam Strategic Growth Fund which rank ninth and eighth, respectively. Philequity PSE Index Fund garnered the first position when Jensen s alpha is used as a basis of comparison. The Fund has positive an alpha of which means that this portfolio exceeded it s required rate of return. The required rate of return of a portfolio is that return based on the capital asset pricing model earlier discussed in this study. It is the hurdle return that a fund should overcome. Only three Funds have exceeded their corresponding required rates of return-- Philequity PSE Index Fund, Philequity Fund and Philippine Stock Index Fund. The other six mutual funds failed to beat their required rates of return. The information ratio, among other things, measures the ability of a portfolio manager in terms of asset allocation and market timing. Based on this ratio, the best managed fund is Philippine PSE index Fund with an information ratio of This mutual fund is being managed by BPI Investment Management, Inc. The second and thirdare Philequity PSE Index Fund and Philequity Fund, respectively. Overall, the best performing equity mutual fund, after adding their individual rank scores per risk-adjusted measure, is Philequity PSE Index Fund while the worst performing fund is United Fund. 5.2 The cross-correlation of the different measures The examination of the correlation existing between and among the ratios was inspired by Reilly and Brown (2012) as cited by Almonte (2013). Based on Table 4, the four measures of risk-adjusted returns support each other as each one is consistent in ranking the performance of the equity mutual funds, and the correlation coefficients are highly significant with Pearson correlation coefficients ranging from to Table 4: Pearson Paired Correlation Coefficients of 4 Risk-Adjusted Performance Measures Sharpe ratio Treynor's ratio Jensen's alpha Information ratio Sharpe ratio Treynor's ratio Jensen's alpha Information ratio The test of significance of the differences between paired measures Using a two-sample significance two-tailed test with α =0.05, the null hypothesis that there is no significant difference between the Sharpe Ratio and Treynor s Ratio is rejected with p value = The Sharpe Ratio and Treynor s Ratio are therefore statistically different from each other.on the other hand, there is no statistical difference between the Sharpe Ratio and Treynor s Ratio. The null hypothesis is rejected with a p value = and using a two-sample significance two-tailed test with α =0.05. The Sharpe Ratio and Jensen s Alpha are therefore statistically different. Applying a two-sample significance two-tailed test with α =0.05, the null hypothesis that there is no difference in the Sharpe Ratio and Treynor s Ratio is rejected with p value = E-8. The Sharpe Ratio and Information Ratio are therefore statistically different. Using a two-sample significance two-tailed test with α =0.05, the null hypothesis that there is no difference between Treynor s Ratio and Jensen s Alpha is rejected 205

7 with p value = The Treynor s Ratio and Jensen s Alpha are therefore statistically proven different from each other. The null hypothesis that there is no statistically significant difference between Treynor s Ratio and Information Ratio is rejected with p value = 5.458E-05. The Treynor s Ratio and Information Ratio are therefore statistically different. The null hypothesis that there is no difference in the Jensen s Alpha and Information Ratio is rejected with p value = The Jensen s Alpha and Information Ratio are therefore statistically different. Table 11: Performance of Mutual Funds Adjusted for Risks and Not Adjusted for Risks Average Sharpe Sharpe Treynor's Treynor's Jensen's Jensen's Information Average Annual Mutual Fund Ratio Ratio Ratio Ratio Alpha Information alpha Ratio Ranking Ranking Ranking Ratio Annual Return Ranking Return * Ranking 1 First Metro Save and Learn Equity Fund (0.115) 4 (0.442) ALFM Growth Fund (0.298) 8 (0.602) ATRAM Philippine Equity Opportunity Fund (0.158) 6 (0.528) Philam Strategic Growth Fund (0.274) 7 (0.950) Philequity Fund Philequity PSE Index Fund Philippine Stock Index Fund Sun Life Prosperity Philippine Equity Fund (0.137) 5 (0.730) United Fund (0.484) 9 (1.278) Based on Sharpe Ratio, Philippine Stock Index Fund is ranked third and not second when it was not adjusted for unsystematic risk.using Treynor s ratio, Philequity PSE Index Fund ranked number 3 and not number 1 when it was adjusted for systematic risk. Philam Strategic Growth Fund was number 8 not number 7.Based on Jensen s alpha, Philippine Stock Index Fund ranked number 3 from number 2 without adjusting for risk. Only Philequity Fund, Philequity PSE Index Fund and Philippine Stock index Fund had a positive Jensen s alpha value; this means that they beat their required rates of return based on the capital asset pricing model (CAPM). The CAPM was developed and tackled by Jack Treynor (1962b), William Sharpe (1964), John Lintner (1965a,b) and Jan Mossin (1966) independently, building on the earlier work of Harry Markowitz on riskvariance optimization and modern portfolio theory.based on Information ratio, Sunlife Prosperity Philippine Equity Fund ranked seventh not fourth, and Philequity PSE Index Fund was second not first without adjusting for risk. PSEi s average annual performance for the past five years was 10.26%. Only Philequity Fund, Philequity PSE Index Fund and Philippine Stock index Fund were able to outperform the PSEi during that period. It is therefore better for investors to merely invest in a passively-managed mutual funds than with an activelymanaged mutual funds. Besides, the management fees of actively managed funds are higher than theircounterpart passively-managed funds. 206

8 The overall best performing mutual fundfor the five-year period ending December 31, 2016 after adding their individual ranking per risk-adjusted measure is Philequity PSE Index Fund while the worst performing equity mutual fund is United Fund. 6. CONCLUSIONS This study showed that the performance ranking of some Philippine equity mutual funds deteriorated after adjusting their returns for both diversifiable and non-diversifiable risks.all four risk-adjusted measures used in this study supported each other as shown by the significant correlation coefficients of each paired combination of measures.the two index tracker funds are not closely and accurately tracking the PSEi, their chosen index benchmark. This paper also showed that the four risk-adjusted measures are statistically different from each other. Measuring investment performance of mutual funds adjusted for risks is important toinvestors especially for those who are risk-averse. Only two out of the nine Philippine equity mutual funds were able to outperform the PSEi. It is therefore better for investors to just put their money in passively-managed mutual funds, than in actively-managed mutual funds, where the returns are better and expenses are lower. 7. RECOMMENDATIONS From the results of this study, one concrete recommendation is for the Philippine Investment Funds Association (PIFA) to change its basisof determining the best performing funds based on their risk-adjusted returns. In this way, mutual fund investors will not only see gross investment returns but also returns that are adjusted for risks. The four measures used in this study can also be applied to unit investment trust funds being offered by the banks and to variable investment linked products being sold by life insurance companies. These products are similar to mutual funds. For future research, a parallel three-year study may be done to see how the funds performed over a shorter period of time. This shorter period will already cover more equity mutual funds in the study, i.e. including the six equity mutual funds that were not included in this research because they are relatively new. Furthermore, the methodology adopted in this study may be applied, together with the statistical tests, to another fund categories like balanced mutual funds and fixed-income mutual funds. Lastly, another good measure of risk-adjusted investment returns called Modigliani and Modigliani or M 2 (Modigliani, 1997) may also be added in future research related to this one. 8. REFERENCES Almonte, C.K.S. (2012). The risk-adjusted performance of equity and balanced funds in the Philippines. International Journal of Information Technology and Business Management29th June Vol.14 No.1 Badillo, R, Chang, J, and Lagamayo (2003). A study on the relationshipof risk and performance of mutual funds in the Philippines in terms of fund category and time frame from Unpublished manuscript, Financial Management Department, De La Salle University Manila, Philippines. 207

9 Blatt, Sharon (2004). An in-depth look at the information ratio. Unpublished Master of Science In Mathematical Science Thesis. Worcester Polytechnic Institute Bangko Sentral ng Pilipinas (2016, April 2). Treasury bill rates. Retrieved on February 20, 2017, from Grinold, R. and Kahn, R.(2000). Active Portfolio Management, New York: McCraw-Hill, Jensen, M. (1968).The performance of mutual fund in the period , Journal of Finance,23, Lintner, John (1965). The valuation of risk assets and the selection of risky investments in stock portfolios and capital budgets, Review of Economics and Statistics, 47 (1), Markowitz, H. (1952). Portfolio selection. Journal of Finance, 7, Microsoft Excel 2013 [Computer software]. Software used to calculate the Treynor, Sharpe, and information ratios and Jensen s alpha. Modigliani, Franco (1997). Risk-adjusted performance. Journal of Portfolio Management (Winter): Mossin, Jan. (1966). Equilibrium in a Capital Asset Market, Econometrica, Vol. 34, No. 4, pp Philippine Investment Funds Association (2017, January 12). Facts & figures: NAVPS performance. Retrieved on February 20, 2017, from Reilly, F.K. & Brown, K.C. (2012). Evaluation of portfolio performance. Analysis of investments & management of portfolios (10th international edition) ( ). Canada: South-Western, Cengage Learning. Sharpe, William F. (1964). Capital asset prices: A theory of market equilibrium under conditions of risk, Journal of Finance, 19 (3), Sharpe, W.F. (1966). Mutual fund performance. Journal of Business, 39(1), Retrieved on February 20, 2017, from EBSCO host (Business Source Complete). Treynor, J. L. (1965a). How to rate management of investment funds. Harvard Business Review, 43(1), Retrieved on February 20, 2017, from EBSCO host (Business Source Complete). Treynor, J. L. (1962b). Toward a Theory of Market Value of Risky Assets. Unpublished manuscript. A final version was published in 1999, in Asset Pricing and Portfolio Performance: Models, Strategy and Performance Metrics. Robert A. Korajczyk (editor) London: Risk Books, pp