Historical Performance and characteristic of Mutual Fund

Historical Performance and characteristic of Mutual Fund Wisudanto Sri Maemunah Soeharto Mufida Kisti Department Management Faculties Economy and Business Airlangga University Wisudanto@feb.unair.ac.id ABSTRACT This research examines recent past performance and fund characteristics that affect to performance of Equity mutual fund measured by Jensen Alpha. The characteristics examined include Fund Size, Fund Age, Net Asset Value, and Fund Growth. This research used 33 mutual funds equity as a sample during 2010-2013. The hypotheses were tested using panel data regression with Fixed Effect Model. Different with Belgacem and Hellara (2011), The Results indicated past performance, Fund Size has negative effect to equity fund performance and Fund Growth have positive effect to equity fund performance. The findings also find same thing show that Fund Age have positive effect to equity fund performance. However, Net Asset Value was found have no significant influence to equity fund performance. In term of that, Net Asset Value is not a good predictor of future performance. Fund managers should understand the characteristics that will affect fund performance and develop strategies on how to increase their funds performance. Keywords: equity fund, past performance, performance, fund characteristic 1. Introduction Over the past decade, mutual funds have been the fastest growing institutions in the world as they manage the risk management tools through diversification. In Indonesia mutual fund is one of attractive investment alternative, began at 1995 with one product and in 2013 mutual fund securities firms issuing 794 mutual fund products. Mutual fund have amazing growth, it net asset value (NAV) grows more than 30% during 2008 to 2013 we can see at table 1. The growing number of mutual funds share sold and their NAV indicated that mutual funds are becoming a popular alternative of investment. They are spread in 4 main categories in term on underlying asset; fixed asset mutual fund, equity mutual fund, balance mutual fund, and money market mutual fund. Equity mutual fund invested portfolio asset 80% in stock market, so NAV will be fluctuated becoming stock market price in Bursa Efek Indonesia (BEI). There is 33 equity mutual fund securities firms issuing,

because many alternatives to invest in equity mutual fund and investor want to maximalist their wealth, so the big question is: how do we choose the right equity mutual fund? Investors must observe mutual fund performance, and analysis factor affecting performance to maximalist their profit. There are numerous studies that try to identify performance difference across funds and predict mutual fund performance. Asset valuation performance of an investment not only based on the level of profits generated, but also considers the risk generated. Further analysis is needed to identify factors related to performance of equity mutual fund. Several empirical studies highlight the impact of past performance on future performance. Year Table 1 Growth of Mutual Funds and Net Asset Value Year 2010-2013 Number of mutual funds Net Asset Value (NAV) (in million Rupiah) Number of mutual funds share sold (in million share) 2010 616 144.704.495 82.079 2011 671 167.231.999 98.982 2012 754 187.591.770 113.714 2013 794 190.544.534 120.886 We highlight the impact of past performance on two steps: first step is reviews studies conducting an empirical analysis on the impact of past performance on future performance. Many investors believe that the management quality of manager is revealed through his past performance, and that is why the impact of past performance has been subject of numerous publications. Second, investigate other factors that may explain mutual fund performance. The purpose of this study is to examine whether past performance equity mutual fund, fund age, fund size, net asset value and fund growth influence equity mutual fund performance in Indonesia. This study allows both investments professional to better serve the needs of their clients, and investors to monitor and evaluate the performance of their investment. This paper provides information to foreign investors for investing in Indonesia capital market. The remainder of this paper is structured as follows: Section 2 outlines the literature review relating to the conceptual basis for mutual fund characteristics, which are believed to influence the mutual fund performance and followed by hypothesis. Section 3 explains the model analysis. Section 4 we present the data description and result. Section 5 contains conclusion. 2. Literature review 2.1 Modern Portfolio Theory A mutual fund is an investment vehicle that pools capital (in Indonesia called NAB) from clients purchasing their shares to investment in portfolio of securities, with purchasing and selling securities being decided by a fund manager (Reilly and Brown, 2011). To invest in

portfolios of securities we must obey a proverb wisdom, which has dictated not put all your eggs in one basket. In more technical terms, this adage is addressing the benefits of diversification. In essence, that adage means that putting all your money in investments that may all go broke at the same time. This is because if any one single investment will goes broke, it is very likely due to its high correlation with the other investments are also going to go broke, leading to the entire portfolio going broke. Figure 1 The MPT Investment Process Expected Return Model Volatility dan Correlation Estimates Portfolio Optimization Risk-Return Efficient Frontier Constrain on Portfolio Choice InvestorObjectives Optimal Portfolio Fabozzi, Gupta and Markowitz (2002): The legacy of modern potfolio theory. the Journal of investing Modern Portfolio Theory (MPT) quantified the concept of diversification by introducing the statistical notion of covariance or correlation (Fabozzi et al., 2002). Figure 1 presents a summary of the MPT investment process like mean-variance optimization or the theory of portfolio selection. MPT dictates that given estimates of the returns, volatilities, and correlations of a set of investments and constraints on investment choices, it is possible to perform an optimization that results in the risk / return or mean-variance efficient frontier. This frontier is efficient because underlying every point on this frontier is a portfolio that results in the greatest possible expected return for that level of risk or results in the smallest possible risk for that level of expected return. The portfolios that lie on the frontier make up the set of efficient portfolios. 2.2 performance equity mutual fund It is impossible to avoid risk when investing in mutual funds, Jensen (1968); Sharpe (1964); Treynor and Black (1973) developed standards to measure risk-adjusted return. Sharpe (1964) studied the performance of 34 mutual funds during the years 1954-1963 to test why some of mutual fund performed better than others, and they could beat the market. He concluded that there are differences among funds, and to major extend, could be explained by differences in expense ratio, skill and past performance. Jensen (1968) performed a similar study during the

year 1955-1964, he studied the performance of 115 mutual fund. His study revealed that the beta value of fund on average were below 1, which implies that on average they took on a lower risk compared to the market. The study also shows the funds returned worse when adjusted for systematic risk. 2.3 Past performance equity mutual fund and performance There is an important number of empirical literatures testing the persistence of mutual fund performance. Jensen (1968),Sharpe (1964); Treynor and Black (1973) have research that support efficient market by denying the ability of fund manager to beat a risk-adjusted market portfolio. Ippolito (1993), Grinblatt and Titman (1992), Bollen and Busse (2005) have research opposite market efficiency conclusion by finding evidence of repeated winners among fund manager and positive performance persistence. Hendricks et al. (1993) and Goetzmann and Ibbotson (1994) asserted that past performance of fund provides useful information for predicting future returns. In addition, they showed that manager who achieved superior performance over reference period tends to be more consistently successful. We can also say, fund underperforming other funds, this year is likely to continue underperforming them next year. Although the results are mixed, it is believed that the mutual fund past performance of Indonesia equity mutual funds has some impacts on equity mutual fund performance. Hence, the following hypothesis is developed: H1: past performance has impact on equity mutual fund performance 2.4 Fund age and performance Gregory et al. (1997) says, age of a mutual fund could play a role in deciding performance since younger mutual funds may face significant higher costs in their start-up period. This is due not only to marketing costs but also the initial cash flows as it will place a greater burden on the fund s transaction costs. There is also evidence showing return of new mutual funds may be affected by a learning period. The study provided evidence that mature funds perform better than younger ones. Bauer et al. (2007) says that one of the reasons of underperformance of younger funds is their exposure to higher market risk since they are invested in fewer stocks. A study made by OttenB and Bams (2002) showed a conversed relationship between mutual fund age and performance, younger funds did better than mature ones. Other side research study made by Peterson et al. (2001) was found no relationship between performance and fund age. There is a relationship between mutual fund age and mutual fund size; young mutual funds tend to be smaller than older ones, which make the young mutual funds return and rating more vulnerable for manipulation. Although the results are mixed, it is believed that the mutual fund age of Indonesia equity mutual funds has some impacts on equity mutual fund performance. Hence, the following hypothesis is developed: H2: Fund age has impact on equity mutual fund performance.

2.5 Fund size and performance Droms and Walker (1994) say that the effect of asset size on investment performance is that investment performance decreases with increases in asset size. However, small funds may be more susceptible to survivorship bias and may experience higher transaction costs than larger funds because they cannot take advantage of certain economies of scale (Grinblatt and Titman, 1989). Grinblatt and Titman (1989) studied fund performance over the period 1975 1984 where fund performance was ranked by asset size and divided into quintiles. Some evidence for superior performance was discovered in the smallest quintile. However, the returns were not significantly different from the return of funds in larger quintiles. Assuming size matters, and wealth erodes performance mutual fund, Indro et al. (1999) argued that mutual funds must attain a minimum fund size in order to achieve sufficient returns and the marginal returns become negative when the mutual fund exceeds its optimal fund size due to costs of acquiring and trading on information. Besides, their work highlights the fact that larger managers capture an increased level of attention, and their relative ability to trade without signaling to the market becomes increasingly constrained as assets size increases. They argue that as mutual funds grow, they must invest in more stocks, which inevitably become less consistent with the investment style. Chen et al. (2004) also investigated performance mutual fund depends on size. The study covers the period 1962 1999. They found strong evidence that fund size erodes performance mutual fund, and that this relationship was not driven by heterogeneity in fund style. Instead, they found that the impact of fund size is most pronounced for funds buying small cap stocks, suggesting that liquidity is an important reason why size erodes performance. They also found evidence arguing that organizational diseconomies related to hierarchy costs could play a role in addition to liquidity. Moreover, findings revealed that mutual funds belonging to large fund companies performed better than others. Gallagher (2003) performed a study on Australian market. They examined the performance of actively managed mutual funds during 1991 2000 and to what extend fund size and manager size are related to risk-adjusted return. Their study did not find any significant difference in performance between big and small funds. Furthermore, Droms and Walker (1994, 1996) found that fund performance is not affected by fund size which was measured by asset size. Measuring fund size based on net asset value, Grinblatt and Titman (1989) find evidence that portfolio of mutual funds with the smallest net asset value shows the highest transaction costs, largest survivorship, and the largest performance. However, because of the high transaction costs of these funds, their actual returns did not actually achieve abnormal performance. In contrast, OttenB and Bams (2002) reported that the larger fund assets are associated with higher returns. Similarly, Ferreira and Matos (2008) in their study on international mutual fund from 19 countries between 1999 and 2005, found that good performance occurs among large funds. Evidence of positive influence of fund size on fund performance may suggest that larger funds take advantage of economies of scale by spreading higher transaction costs over a larger asset base which in turn leads to better fund performance.

Meanwhile, Chen et al. (2004) in their cross-sectional analysis of performance components revealed that fund size is negatively related to fund performance. They argued that after funds reach a certain size, they no longer care about maximizing returns. They suggested that liquidity and diseconomies of scale related to hierarchy costs cause size to erode performance. Indro et al. (1999) found that actively managed mutual funds have to attain a minimum fund size before they achieve returns sufficient to cover their costs for acquiring and trading on information. They also found that there are diminishing marginal returns to information activities and that the marginal returns become negative when a mutual fund exceeds its optimal size. In terms of fund size related to investments made by funds across smaller capitalization, equity research is limited. Using a sample of 219 small-cap mutual funds, a study in U.S. by Christopherson et al. (2002) revealed an inverse relationship between fund size and performance. Although the results of previous researches are mixed, it is believed that Indonesia equity mutual fund size influences Equity mutual fund performance as stated in the following hypothesis. H3: fund size influences equity mutual fund performance. 2.6 Net asset value and performance Investor may also pay attention to NAV which seems partly conditional to capital flows. The lower it is the greater probability to attracting new investors and gain market share. Khorana and Servaes (2001) the NAV determines the flexibility of investment. Grinblatt and Titman (1989) find evidence that portfolio of mutual funds with the smallest NAV shows the highest transaction costs, largest survivorship, and the largest performance. Although the results are mixed, it is believed that the NAV of Indonesia equity mutual funds has some impacts on equity mutual fund performance. Hence, the following hypothesis is developed: H4: Net asset value influences equity mutual fund performance. 2.7 Fund growth and performance Beliefs of investors manifested in money flow to mutual funds also seem to contain some information about future performance. Gruber (1996) and Zheng (1999) note that if investors have a great incentive to buy the past performance and that past performance is informative about future performance, then flows also have information content. Although the results are mixed, it is believed that fund growth of Indonesia equity mutual funds has some impacts on equity mutual fund performance. Hence, the following hypothesis is developed: H5: Fund growth influences fund performance.

3. Model anlaysis Existing empirical studies on mutual fund literatures frequently reaches conflicting conclusion regarding the ability of equity mutual fund managers to beat the market and the impact past performance, and mutual fund characteristics (fund age, fund size, net asset value, and fund growth) on fund performance. Hypothesis that we build suggest the relationship between performance equity mutual fund, past performance and mutual fund characteristics are shown in Figure 2. Figure 2 Past performance Fund age Fund size Performance Equity Mutual Fund NAV Fund growth Pas performance, fund age, fund size, NAV, and fund growth are expected to influence fund performance. These fund characteristics are important and useful factors for investors to make decisions regarding mutual funds that provide good returns. Literature has shown that Pas performance, fund age, fund size, NAV, and fund growth may impact fund performance either positively or negatively. To explain the relationship between the independent variables that past performance, fund age, fund size, NAV, and fund growth to variable dependent mutual funds performance, it can be used multiple linear analysis model with the formula: Perf it = β 0 + β 1perf it-1 + β 2size i,t-1 + β 3age i,t-1 + β 4NAVvalue i,t-1 + β 5flow i,t-1 + ε Perf it: Performance Equity mutual fund i in period t perf it-1: Performance Equity mutual fund i in period t-1 β 0: Constanta Equity mutual fund i in period t size i,t-1: Fund size Equity mutual fund i in period t age i,t-1: Fund age Equity mutual fund i in period t NAVvalue i,t-1: NAV Equity mutual fund i in period t flow i,t-1: Fund Flow Equity mutual fund i in period t ε: Error This study use purposive sampling, because sampling procedure using certain limitations of existing discretion. Criteria specified in the sampling are as follows: a. Mutual Funds and Collective Investment Contract is open b. Mutual funds diversified equity funds (investing at least 80% of funds in equity)

c. Mutual active and registered in the Financial Service Authority during the period research d. Announcing the net asset value on a consistent basis 2009-2012 3. Data description and results Objects used in this study is a mutual fund company shares are active and registered in the Financial Services Authority Indonesia for the period 2009-2013. Total sample is 33 equity mutual funds with 21 investment manager. 150 observations consisted of 33 equity mutual funds with a four-year period. Table 2 Source: SPSS Output Shows at Table 2, mutual funds that have the lowest past performance (PAST) equity mutual funds Evolving with an alpha Jensen value -0.018, whereas a mutual fund has the highest historical performance have an alpha Jensen value 0.047. The average value of historical performance is 0.004 with a standard deviation amounted 0,011. The magnitude of the standard deviation in 2010-2013 is relatively high because the sample average value is lower than the standard deviation value. The lowest value of the fund size (SIZE) is 22.497, while the highest score is 30.313. Fund size has an average value 26.337 with standard deviation 1.693. The oldest fund age (AGE) is 16, 42 year (it means, 16 year and 5 month) and the younger is 1, 17 year (it means, 1 year and 2 month). The lowest value of NAV is Rp 6.500, while the highest is Rp 10.500. NAV has an average value Rp 8.100 with standard deviation 0.90. The lowest value of fund growth is -7, 8%, while the highest is13, 64%. fund growth has an average value 0,2% with standard deviation 0,042. While the dependent variable of this study is the performance of mutual funds stocks with the lowest value Jensen alpha -0.018, while the highest value Jensen alpha 0,056. Average value equity mutual fund performance was 0.002 with a standard deviation of 0.011. Magnitude standard deviation indicates that in 2010-2013 the value of diversity performance on a sample of mutual funds is relatively high because the average value is lower compared with the standard deviation values.

Table 3 Panel Data Regression with Fixed Effect Model Based on table 3, the past performance variables (PAST) had a negative effect with regression coefficient of -0.4074 on the performance of Equity mutual fund. This means that if the historical performance increases value of one unit, it will decrease the value of Equity mutual fund performance -0.4074 units assuming other variables remain. The fund size variables (SIZE) had a negative effect with regression coefficient of -0.0049 on the performance of Equity mutual fund. This means that if the historical performance increases value of one unit, it will decrease the value of Equity mutual fund performance -0.0049 units assuming other variables remain. The

fund age variables (AGE) had a positive effect with regression coefficient of 0.0037 on the performance of Equity mutual fund. This means that if the historical performance increases value of one unit, it will increase the value of Equity mutual fund performance 0.0037 units assuming other variables remain. NAV has a significance value 0.6265 > 0.05, so NAV had no significant effect on the performance of mutual funds stock. The fund growth variables (GROWTH) had a positive effect with regression coefficient of 0.0192 on the performance of Equity mutual fund. This means that if the fund growth increases value of one unit, it will increase the value of Equity mutual fund performance 0.0192 units assuming other variables remain. 4. Conclusion Past performance, Fund Size has negative effect to equity fund performance, and Fund Growth, Fund Age has positive effect to equity fund performance. However, NAV was found have no significant influence to equity fund performance. In term of that, NAV is not a good predictor of future performance. Reference Bauer, R., Derwall, J., & Otten, R. (2007). The ethical mutual fund performance debate: New evidence from Canada. Journal of Business Ethics, 70(2), 111-124. Belgacem, S. B., & Hellara, S. (2011). Predicting Tunisian mutual fund performance using dynamic panel data model. Journal of Risk Finance, The, 12(3), 208-225. Bollen, N. P. B., & Busse, J. A. (2005). Short-term persistence in mutual fund performance. Review of Financial Studies, 18(2), 569-597. Chen, J., Hong, H., Huang, M., & Kubik, J. D. (2004). Does fund size erode mutual fund performance? The role of liquidity and organization. The American Economic Review, 94(5), 1276-1302. Christopherson, J. A., Ding, Z., & Greenwood, P. (2002). The perils of success. The Journal of Portfolio Management, 28(2), 41-53. Droms, W. G., & Walker, D. A. (1994). Investment performance of international mutual funds. Journal of Financial Research, 17(1), 1-14. Droms, W. G., & Walker, D. A. (1996). Mutual fund investment performance. The Quarterly Review of Economics and Finance, 36(3), 347-363. Fabozzi, F. J., Gupta, F., & Markowitz, H. M. (2002). The legacy of modern portfolio theory. The Journal of Investing, 11(3), 7-22. Ferreira, M. A., & Matos, P. (2008). The colors of investors money: The role of institutional investors around the world. Journal of Financial Economics, 88(3), 499-533. Gallagher, D. R. (2003). Investment manager characteristics, strategy, top management changes and fund performance. Accounting & Finance, 43(3), 283-309. Goetzmann, W. N., & Ibbotson, R. G. (1994). Do winners repeat? The Journal of Portfolio Management, 20(2), 9-18. Gregory, A., Matatko, J., & Luther, R. (1997). Ethical unit trust financial performance: small company effects and fund size effects. Journal of Business Finance & Accounting, 24(5), 705-725.

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