Market Timing Ability and Stock Selection Skills of the Fund Manager

Transcription

1 CHAPTER 6 Market Timing Ability and Stock Selection Skills of the Fund Manager Chapter 6 Market Timing Ability of the Fund Manager Page 148

2 MARKET TIMING ABILITY AND STOCK SELECTION SKILLS 6.1 Introduction OF THE FUND MANAGER The final stage of the process of investment management is to construct a portfolio and revise it frequently. Great care needs to be taken while revising a portfolio. Revision of portfolio essentially means securities with high risk and low return should be replaced with the securities having higher return and relatively lower risk. This task requires skill and expertise on part of the fund manager. Churning of the portfolio is dependent on the investment objective of the fund. In order to achieve investment objectives, a mutual fund manager can either pursue an active fund management strategy or a passive fund management strategy. An active fund management strategy calls for the fund manager to have a good market timing ability. Fund managers that pursue an active strategy with respect to the market component are known as market timers. Portfolio managers vary the cash position of their portfolio based on market forecast. In a rising market, the fund manager would normally raise the risk of his portfolio either by shifting from cash to stocks, or by raising the beta of the equities in the portfolio, or a combination of both. The same principle applies in the falling market, where the fund manager would decrease the risk of the portfolio by shifting to cash from equities or by decreasing the beta of the equities portion on the portfolio, or combination of both. However, in a passive fund management strategy, the fund manager constructs a portfolio that replicates the index (benchmark). In this strategy, the fund manager is free from the responsibility Chapter 6 Market Timing Ability of the Fund Manager Page 149

3 of market timing and stock selection skills. Passive management is an attempt to construct a portfolio that mimics the overall market return. The previous chapter has discussed about the various fund characteristics that have an impact on the performance of a mutual fund. In addition to the factors discussed earlier viz; Fund size, Portfolio turnover rate, Fund age and Expense ratio of the fund, one of the factors most widely researched is Market timing ability of the fund manager and his stock selection skills. The fund manager s market timing capacity and his stock selection expertise have been studied independently or in combination with a choice of other factors influencing the performance of the manager s portfolio. Timing the market refers to shifting funds into and out of the stocks depending on market forecasts and estimated risk premium. Market timing ability of the fund manager basically focuses on whether the manager is capable enough to earn superior returns on his portfolio by timing the market. Simply put, it means whether the fund manager is able to predict the rise in the market and accordingly increase his investments in advance and conversely predict the fall in the market and decrease his investments in advance. It focuses on his ability to enter into a market when he anticipates the market to rise and to exit from the market in case he anticipates a downturn. Fund managers have access to information that is not easily available to common investors. He is supposed to possess superior analytical skills and expertise in timing the market for making investment decisions. He is expected to provide a high rate of return on managed portfolios with his careful timing and selection ability. This factor examines whether a fund manager is able to outperform the market with his timing Chapter 6 Market Timing Ability of the Fund Manager Page 150

4 ability and stock selection skills. Fund managers forecasting skills could be divided into two distinct components, viz. predicting price movements of individual securities, also termed as Micro forecasting or security analysis, and predicting price movements of the stock market as a whole, also termed as Macro forecasting or market timing (Fama, 1972 in Lee and Rahman,1990). A successful market timer is the one who can increase the portfolio weight on equities prior to a rise in the market and decrease the weight on equities prior to a fall in the market (Bollen and Busse, 2001). Evaluating the market timing ability and stock selection skills of the fund manager as a factor affecting the performance of mutual funds came into limelight with a study carried out by Treynor and Mazuy in They developed a model for testing the market timing ability of a mutual fund manager based on a regression analysis of the managed portfolio s realised returns, which includes a quadratic term. They used 57 open-ended Mutual funds during the period of Their results reported no evidence that managers have outperformed the market. This chapter analyses the Indian mutual fund managers skill in timing the market and examines their capability in selection of securities to earn better returns. For this purpose, Treynor and Mazuy Model (1966) is used. Chapter 6 Market Timing Ability of the Fund Manager Page 151

5 6.2 Treynor and Mazuy Model (Model for Market Timing) Treynor and Mazuy model was developed by Treynor and Mazuy in 1966 to test market timing abilities of a mutual fund manager. They suggested that, a squared term should be added to the simple linear relationship model which is given as under: R p -R f = α + b (R m -R f ) + γ (R m -R f ) 2 + e p Where, R p = Return on the fund portfolio for specified period R m = Return on the market R f = Risk free rate of return e p = the error term and, α, b and γ are parameters of the model In this regression model, there are two independent variables, i.e. excess return on the market portfolio and the square of the excess return. This model is a form of polynomial regression model. Though this model uses quadratic term of the independent variable it does not suffer from the problem of multicollinearity. The parameters of the model are α, b and γ. The parameter γ indicates the fund manager s market timing ability whereas the parameter b indicates the fund manager s stock selection skills. If the value of parameter γ is significantly positive, it indicates that the fund manager is able to time the market in the right direction and vice versa. In other words, mutual fund managers possess skill in timing the market when the relation between the market sensitivity and the realised market return is Chapter 6 Market Timing Ability of the Fund Manager Page 152

6 significantly positive (Swinkels & Tjoe, 2006). A value of parameter γ greater than zero indicates market timing ability. The logic is that, when the market goes up, the successful market timing fund will go up by a disproportionate amount (Chen et al, 2010). The parameter b indicates stock selection skills of a fund manager. The underlying principle of the equation is that if a fund manager is not engaged in market timing and concentrate only at the stock selection, the average beta of the fund would be constant. In that case fund return would have a straight-line linear relationship with the market return. With reference to objective 2 of the study, market timing ability and stock selection skills of the fund manager are studied by formulating the following research hypothesis. This research hypothesis needs to be tested to draw the statistical inferences. Null Hypothesis (H0): Mutual Fund Managers do not possess the requisite market timing ability and stock selection skills and hence they do not outperform the market. Alternate Hypothesis (H1): Mutual Fund Managers possess good market timing ability and stock selection skills and hence they are able to outperform the market. Chapter 6 Market Timing Ability of the Fund Manager Page 153

7 6.3 Empirical Analysis The Treynor and Mazuy Model (1966) is run using the data of fund return, market return and risk free rate of return. The following Table displays the results of the same. Table 6.1: Results of Treynor and Mazuy Model SR ADJ. DW NAME OF THE FUND b t (b) γ t (γ) NO R 2 TEST 1 BIRLA SUNLIFE ADVANTAGE (DIV) *** BIRLA SUNLIFE ADVANTAGE (GR) *** * BIRLA SUNLIFE EQUITY (DIV) *** BIRLA SUNLIFE EQUITY (GR) *** * DSPBR OPPORTUNITIES (DIV) DSPBR OPPORTUNITIES (GR) *** DSPBR EQUITY (DIV) *** * FRANKLIN INDIA BLUE CHIP (DIV) *** * FRANKLIN INDIA BLUE CHIP (GR) *** FRANKLIN INDIA PRIMA PLUS (DIV) *** FRANKLIN INDIA PRIMA PLUS (GR) *** FRANKLIN INDIA PRIMA (DIV) *** FRANKLIN INDIA PRIMA (GR) *** HDFC TOP 200 (DIV) *** HDFC TOP 200 (GR) *** HDFC CAPITAL BUILDER (DIV) *** HDFC CAPITAL BUILDER (GR) *** ** HDFC EQUITY (DIV) *** HDFC EQUITY (GR) *** HDFC GROWTH (DIV) *** *** HDFC GROWTH (GR) *** ICICI PRUDENTIAL TOP 200 (DIV) *** ICICI PRUDENTIAL TOP 200 (GR) *** ** ING CORE EQUITY (DIV) *** ING CORE EQUITY (GR) *** JM EQUITY (DIV) *** JM EQUITY (GR) *** KOTAK 50 (DIV) *** KOTAK 50 (GR) *** Chapter 6 Market Timing Ability of the Fund Manager Page 154

8 SR NO NAME OF THE FUND b t (b) γ t (γ) ADJ. R 2 DW TEST 30 LIC NOMURA EQUITY (DIV) *** LIC NOMURA EQUITY (GR) *** LIC NOMURA MF GROWTH (GR) *** *** MORGAN STANLEY GROWTH (GR) *** PRINCIPAL GROWTH (DIV) *** ** PRINCIPAL GROWTH (GR) *** ** RELIANCE GROWTH (DIV) *** RELIANCE GROWTH (GR) *** RELIANCE GROWTH (BONUS) *** RELIANCE VISION (DIV) *** RELIANCE VISION (GR) *** RELIANCE VISION (BONUS) *** SBI MSFU CONTRA (DIV) *** SBI MSFU CONTRA (GR) *** SBI MAGNUM EQUITY (DIV) *** SBI MAGNUM EQUITY (GR) *** SBI MAGNUM GLOBAL FUND *** (DIV) SBI MAGNUM GLOBAL FUND *** (GR) SBI MAGNUM MULTIPLIER PLUS *** (DIV) 0.89 SBI MAGNUM MULTIPLIER PLUS *** * 49 (GR) SUNDARAM GROWTH (DIV) *** SUNDARAM GROWTH (GR) *** TATA GROWTH (GR) *** *** TATA PURE EQUITY (DIV) *** TATA PURE EQUITY (GR) *** TATA ETHICAL FUND (DIV) *** * TATA ETHICAL FUND (GR) *** ** TAURUS BONANZA (GR) *** *** TAURUS DISCOVERY (GR) *** TAURUS STARSHARE (GR) *** TEMPLETON INDIA GROWTH (DIV) *** *** UTI EQUITY (DIV) *** UTI EQUITY (GR) *** UTI MASTERSHARE (DIV) *** UTI MASTERSHARE (GR) *** UTI MASTER VALUE (DIV) *** UTI MASTER VALUE (GR) *** ** Chapter 6 Market Timing Ability of the Fund Manager Page 155

9 SR NO NAME OF THE FUND b t (b) γ t (γ) ADJ. R 2 DW TEST 67 UTI MASTER PLUS 91 (DIV) *** UTI MASTER PLUS 91 (GR) *** *** *1% significance level **2% significance level ***5% significance level Table 6.1 reports the results of market timing ability of the fund manager using Treynor and Mazuy Model. For calculating significance levels, heteroscedasticity and autocorrelation consistent standard error are used. It is important to obtain heteroscedasticity consistent standard errors because adding a quadratic term gives rise to the problem of heteroscedasticity in the model. The Durbin-Watson test is used to correct any potential serial correlation. The above table displays the value of the parameters along with their t-statistic. It also reports the Adjusted R 2 and Durbin-Watson test value for serial autocorrelation. It reveals that out of 68 open-ended equity diversified mutual fund schemes, 5 schemes viz. Birla Sunlife Advantage Growth Fund, Birla Sunlife Equity Growth Fund, DSPBR Equity Dividend Fund, Franklin India Blue Chip Dividend Fund and Tata Ethical Dividend Fund are positively significant at 1% significance level, 6 schemes namely, HDFC Capital Builder Growth Fund, ICICI Prudential Top 200 Growth Fund, Principal Growth Dividend Fund, Principal Growth Growth Fund, Tata Ethical Growth Fund and UTI Master Value Growth Fund are positively significant at 2% significance level and 3 schemes namely, LIC Nomura MF Growth Growth Fund, Tata Growth Growth Fund and Taurus Bonanza Growth Fund are positively significant at 5% significance level. Chapter 6 Market Timing Ability of the Fund Manager Page 156

10 It indicates that, fund managers in 20% of the schemes are successful market timers. There are 4 schemes for which the t-values are negatively significant. The fund managers of these schemes are not able to succeed in market timing and they tend to time the market in wrong direction. These schemes include HDFC Growth Dividend Fund, SBI Magnum Multiplier plus 93 Growth Fund, Templeton India Growth Dividend Fund and UTI Master plus 91 Growth Fund. Stock selection skills of the fund manager are denoted by the parameter b. The t value of b is significantly positive at 5% significance level for all schemes except DSPBR Opportunities Dividend Fund which indicates that the Indian mutual fund portfolio managers possess excellent stock selection skills for their portfolios. They rely only on their security selection skills for outperforming the market. To summarise, out of the total sample size of 68 open-ended equity diversified mutual fund schemes, the fund managers of 14 schemes are successful market timers, the fund managers of 4 schemes time the market in wrong direction whereas, the remaining 50 schemes do not possess any market timing ability, i.e. they exercise a passive fund management strategy. Chapter 6 Market Timing Ability of the Fund Manager Page 157

11 All the 68 sample mutual fund schemes are classified based on their Assets under Management (AUM) into Quantiles. The classification is given in Table 5.1. Further, we categorize the skills of the fund manager based on Quantiles formed. The following exhibits report the market timing and stock selection results based on the 3 quantiles. SR NO Table 6.2: Results of Treynor and Mazuy Model of Quantile I (Small Size Funds) NAME OF THE FUND b T(b) γ T(γ) ADJ. R2 DW TEST 1 BIRLA SUNLIFE ADVANTAGE (GR) *** * ING CORE EQUITY (DIV) *** ING CORE EQUITY (GR) *** JM EQUITY (DIV) *** JM EQUITY (GR) *** LIC NOMURA EQUITY (DIV) *** LIC NOMURA EQUITY (GR) *** LIC NOMURA MF GROWTH (GR) *** *** PRINCIPAL GROWTH (DIV) *** ** PRINCIPAL GROWTH (GR) *** ** RELIANCE GROWTH (BONUS) *** RELIANCE VISION (BONUS) *** SBI MAGNUM EQUITY (GR) *** SUNDARAM GROWTH (DIV) *** SUNDARAM GROWTH (GR) *** TATA GROWTH (GR) *** *** TATA ETHICAL FUND (DIV) *** * TATA ETHICAL FUND (GR) *** ** TAURUS BONANZA (GR) *** *** TAURUS DISCOVERY (GR) *** TAURUS STARSHARE (GR) *** UTI EQUITY (GR) *** UTI MASTERSHARE (GR) *** UTI MASTER VALUE (GR) *** ** UTI MASTER PLUS 91 (GR) *** *** *1% significance level, **2% significance level, ***5% significance level Chapter 6 Market Timing Ability of the Fund Manager Page 158

12 Table 6.2 displays the results of Treynor and Mazuy Model for Quantile I. Quantile I include 25 small-sized mutual fund schemes, out of which 3 schemes namely, LIC Nomura MF Growth Growth Fund, Tata Growth Growth Fund and Taurus Bonanza Growth Fund have showed positively significant results at 5% level of significance. UTI Master plus 91 Growth Fund reports negatively significant t value, hence the scheme s fund manager does not possess a superior market timing ability. The fund manager tends to time the market in the wrong direction. Birla Sunlife Advantage Growth Fund and Tata Ethical Dividend Fund are positively significant at 1% level of significance. t-values of the following schemes are positively significant at 2% level of significance: Principal Growth Dividend Fund, Principal Growth Growth Fund, Tata Ethical Growth Fund and UTI Master Value Growth Fund. All the mutual fund schemes included in Quantile I display superior expertise in selection of securities. Chapter 6 Market Timing Ability of the Fund Manager Page 159

13 Table 6.3: Results of Treynor and Mazuy Model of Quantile II (Mid-size Funds) SR ADJ. DW NAME OF THE FUND b T(b) γ T(γ) NO R2 TEST 1 BIRLA SUNLIFE ADVANTAGE (DIV) *** BIRLA SUNLIFE EQUITY (DIV) *** BIRLA SUNLIFE EQUITY (GR) *** * DSPBR OPPORTUNITIES (DIV) DSPBR OPPORTUNITIES (GR) *** FRANKLIN INDIA PRIMA PLUS (DIV) *** FRANKLIN INDIA PRIMA PLUS (GR) *** FRANKLIN INDIA PRIMA (DIV) *** FRANKLIN INDIA PRIMA (GR) *** HDFC CAPITAL BUILDER (DIV) *** HDFC CAPITAL BUILDER (GR) *** ** HDFC GROWTH (DIV) *** *** HDFC GROWTH (GR) *** ICICI PRUDENTIAL TOP 200 (DIV) *** ICICI PRUDENTIAL TOP 200 (GR) *** ** KOTAK 50 (DIV) *** KOTAK 50 (GR) *** SBI MAGNUM EQUITY (DIV) *** SBI MAGNUM GLOBAL FUND 94 (DIV) *** SBI MAGNUM GLOBAL FUND 94 (GR) *** SBI MAGNUM MULTIPLIER PLUS 93 (DIV) *** SBI MAGNUM MULTIPLIER PLUS 93 (GR) *** * TATA PURE EQUITY (DIV) *** TATA PURE EQUITY (GR) *** TEMPLETON INDIA GROWTH (DIV) *** *** UTI MASTER VALUE (DIV) *** UTI MASTER PLUS 91 (DIV) *** *1% significance level **2% significance level ***5% significance level Chapter 6 Market Timing Ability of the Fund Manager Page 160

14 Quantile II includes 27 mid-sized mutual fund schemes. Table 6.3 displays the results of Treynor and Mazuy Model for Quantile II. The results display that only 3 schemes are positively significant with their fund managers having superior market timing ability. These are Birla Sunlife Equity Growth Fund at 1% level of significance and HDFC Capital Builder Growth Fund, ICICI Prudential Top 200 Growth Fund at 2% level of significance. The fund managers of HDFC Growth Dividend Fund, Templeton Indian Growth Dividend Fund and SBI Magnum Multiplier plus 93 Dividend Fund does not possess the requisite skills to time the market. With reference to stock selection skills of the Quantile II mutual fund schemes, the fund managers of all the schemes possess superior skills in selecting stocks except DSPBR Opportunities Dividend Fund. Chapter 6 Market Timing Ability of the Fund Manager Page 161

15 Table 6.4: Results of Treynor and Mazuy Model of Quantile III (Large Size Funds) SR ADJ. DW NO NAME OF THE FUND b T(b) γ T(γ) R2 TEST 1 DSPBR EQUITY (DIV) *** * FRANKLIN INDIA BLUE CHIP (DIV) *** * FRANKLIN INDIA BLUE CHIP (GR) *** HDFC TOP 200 (DIV) *** HDFC TOP 200 (GR) *** HDFC EQUITY (DIV) *** HDFC EQUITY (GR) *** MORGAN STANLEY GROWTH (GR) *** RELIANCE GROWTH (DIV) *** RELIANCE GROWTH (GR) *** RELIANCE VISION (DIV) *** RELIANCE VISION (GR) *** SBI MSFU CONTRA (DIV) *** SBI MSFU CONTRA (GR) *** UTI EQUITY (DIV) *** UTI MASTERSHARE (DIV) *** *1% significance level **2% significance level ***5% significance level Table 6.4 reports the results of Treynor and Mazuy Model for Quantile III. Quantile III comprises of 16 large-sized sample mutual fund schemes. All the sample fund schemes included in Quantile III have superior security selection skills. However, the fund managers of only DSPBR Equity Dividend Fund and Franklin India Bluechip Dividend Fund have displayed positively significant market timing ability at 1% level of significance. Rest of the fund managers have failed in timing the market. Chapter 6 Market Timing Ability of the Fund Manager Page 162

16 Table 6.5: Statistical Significance of Timing Parameters TOTAL SAMPLE NUMBER OF SHOWING POSITIVE TIMING PARAMETERS NUMBER OF SHOWING STATISTICALLY SIGNIFICANT POSITIVE TIMING PARAMETERS NUMBER OF SHOWING STATISTICALLY SIGNIFICANT NEGATIVE TIMING PARAMETERS POSITITVE AS % OF TOTAL SIGNIFICANT AS % OF POSITIVE POSITIVELY SIGNIFICANT AS % OF TOTAL SAMPLE % Table 6.5 reveals the statistical significance of timing parameters. Out of the total 68 sample mutual fund schemes examined, 45 funds (66.18%) have displayed positive timing parameters, out of which only 14 funds (31.11%) are showing statistically significant positive timing parameters. Four funds time the market in the wrong direction; they have reported statistically significant negative timing parameters % of the fund managers display statistically significant market timing skill out of total 45 funds displaying positive timing parameters. The overall picture of Indian mutual fund managers with reference to their market timing ability displays that, only 21% out of the total sample 68 mutual funds reports statistically significant market timing ability. This figure is very low to accept the alternative hypothesis formulated. Indian mutual fund managers do time the market perfectly, but this skill of theirs is affected by various unfavourable global and domestic factors that have a negative impact on the Indian stock markets. Further, the market timing skill of the fund manager is examined with respect to a chosen benchmark (CNX Nifty). Thus, the return earned on the fund may differ based on the benchmark chosen by the fund manager to assess his timing skill. Chapter 6 Market Timing Ability of the Fund Manager Page 163

17 Table 6.6: Statistical Significance of Timing Parameters Based on Quantiles FUND SIZE SMALL SIZED (Q1) MID SIZED (Q2) LARGE SIZED (Q3) TOTAL SAMPLE NUMBER OF SHOWING POSITIVE TIMING PARAMETERS NUMBER OF SHOWING STATISTICALLY SIGNIFICANT POSITIVE TIMING PARAMETERS NUMBER OF SHOWING STATISTICALLY SIGNIFICANT NEGATIVE TIMING PARAMETERS POSITIT VE AS % OF TOTAL SIGNIFI CANT AS % OF POSITI VE POSITIVELY SIGNIFICANT AS % OF TOTAL SAMPLE % % % Table 6.6 displays the statistical significance of timing parameters based on Quantiles. Quantile I includes Small Sized Funds (25 Funds). Quantile II comprises of Mid-sized funds (27 Funds) and Quantile III is for Large sized Funds (16 Funds). Among 25 small-sized funds, 64% of the sample funds are able to show positive timing parameters, out of which 56.25% (9) are significantly positive. Among midsized funds, 67% of the sample funds are able to show positive timing parameters, out of which 17% (only 3) are significantly positive. Among large-sized funds, 69% of the sample funds are able to show positive timing parameters, out of which 18% (only 2) are significantly positive. Table 6.6 also reports the percentage of funds displaying significantly positive parameters out of total number of small-sized, mid-sized and large-sized funds. Chapter 6 Market Timing Ability of the Fund Manager Page 164

18 Out of total 25 small-sized funds, 36% of the fund managers reported significantly positive timing skill. 11% of total 27 mid-sized funds have reported superior market timing skill and 13% out of total 16 large size funds have reported statistically significant market timing ability. Based on the above figures, we arrive at a conclusion that, small-sized fund managers possess greater market timing skills visa-vis mid-size and large-sized funds. Small-size funds with a limited corpus at their disposal are able to time the market more efficiently. Fund size is an important parameter that affects the performance of the mutual funds to a greater extent. This characteristic and its impact on the performance of the funds is studied in the following chapter. Chapter 6 Market Timing Ability of the Fund Manager Page 165

19 6.4 Discussion and Conclusion Are the managers of mutual funds good market timers? This research question is addressed in this chapter. This study uses Treynor and Mazuy model (1966) to test the research hypothesis whether the mutual fund managers are able to time the market effectively to earn superior returns. Out of 68 sample mutual fund schemes selected, only 21% have reported significantly positive results with reference to the market timing skills of their managers whereas mutual fund managers of all the sample mutual fund schemes except one, have reported excellent skills in selection of securities for the purpose of investment. The results also reveal that fund managers of small sized funds are able to time the market effectively with 36% of the total small-sized funds showing significant positive results. This can be due to the fact that fund managers of smallsize funds have fewer corpuses at their disposal and hence, they are able to efficiently allocate the amount and assign the percentage of weight to selected securities. We find it hard to accept the alternative hypothesis stating that the Indian mutual fund managers possess market timing ability and security selection skills. No doubt, Indian mutual fund managers do possess excellent stock selection skills, however in terms of market timing ability as few as 21% are proved to be good market timers. This percentage seems very less to accept the alternative hypothesis. Indian mutual fund managers are capable of displaying excellent timing ability if the market conditions are favourable. Secondly, the manager s timing skills also depends on the benchmark chosen with which the portfolio return is compared. Chapter 6 Market Timing Ability of the Fund Manager Page 166

20 Hence it is concluded that, the Indian mutual fund managers must improve their market timing skills by focussing on the external market related information so as to promote the confidence among retail investors who prefer to invest their hard earned money and small savings in mutual funds. The growth of Indian Mutual Fund Industry largely depends on mutual fund managers whose skills in market timing would improve the confidence of the investing public in Mutual Funds Schemes. Chapter 6 Market Timing Ability of the Fund Manager Page 167