[1]

INTRODUCTION:
In recent years Mutual funds have emerged as one of the most attractive tools of investment. Its current trends not only showing increasing preference by big investors in developed countries, but also for small investors mutual funds are one of the most attractive investment opportunities where he can minimize his risk by having a diversified investment portfolio which is handled by the specialized stock brokers. This has led to the creation of sub categories of mutual funds (Huhmann, 2005). The mutual funds can be divided in open and closed ended. Open ended fund is the fund where there is continual subscription and redemption by share holders itself and in close ended funds share are initially offered to common people and then traded in the share market by specialized brokers / investors. In close ended mutual funds, different investors invest with a common aim of good returns and this pool of investment is managed by professionals. In last few decades, investor particularly small investors are taking more interest in choosing mutual funds as first choice of investment. Reason for that is mutual funds provide them the platform to invest in the securities in which they cant invest through usual means. There can also be a discussion on the role of asset Management Company as well, as it facilitates the investors with the services of expert in the field of asset management. The UK mutual fund industry along with the US mutual fund industry is the most important mutual fund industry of the world and so the pivot .center of the study will be the UK mutual fund market. Considering the increasing importance of mutual funds and to study the performance of UK mutual fund industry, there is a need to research & understand the returns associated with the mutual funds, risks attached and the relation between risk and returns.

[2]

OBJECTIVES OF THE STUDY

UK mutual fund industry is a combination of diversifying portfolio mix, investment objectives and managing the funds with skill & expertise. It can be a very complex decision for investor before choosing a right investment proposal. In this study, light will be shed on the concerned topics so the performance of UK mutual funds can be analyzed and growth in this sector can be judged. A major portion of UK fund management companies will be taken into account and will be assessed comparatively to measure the actual performance of the industry. It will not only be a good study for investors but also for fund managers. Along with the main objective of studying the size of UK mutual fund & its performance from 1995-2010, the other objectives of the study are: 1. To measure the return of the equity mutual fund, for the purpose different tools for measuring returns on equity mutual funds will be evaluated. 2. To measure the risk of the equity mutual funds. In achieving this objective, all scenarios will be considered including the relation between funds size and risk etc. 3. To find out the relation between risks and returns in context with mutual funds. How risk is adjoined with returns and how greater returns are conditional to greater risks.

[3]

LITERATURE REVIEW
There were some studies before on the mutual funds which include Jensen (1968) & Sharpe (1966) to compare the risk adjusted returns on the mutual funds using capital asset pricing model (CAPM) i.e. (Rit-Rf) = i + i(Rmt-Rf) + it, which may be the most famous model in comparing risk adjusted return. They were of the view that mutual funds underperform the market indexes and were not adequate to compensate the investors. This model can hold right if CAPM lies on the market line curve along with the alpha value as zero. Alpha value can also be taken as an indication of underperformance or over performance in shape of positive or negative alphas. Moreover it can also indicate more or less risk adjusted performance. Carhart (1997) also did the same study by using CAPM model but he used four variable model of
(Rit-Rf) = i + 1i(Rmt-Rf) + 2i(SMBt) + 3i(HMLt) + 4i(PR1YRt)+ it

Carharts model was based on the studies of French & Fama (1992) who established the three variable model of market to establish the relation between stock return and size. Moreover conditional alpha & beta based models was also reviewed e.g. studies of Ferson & Schdat (1996) was done to know the conditional beta model, Ferson & Glassman (1998) was studies for conditional alpha model. Further some unconditional studies like French & fama were also considered. Some studies were also required to help in guiding the selection of choosing right model for performance measurement and establishing relations among the variables. Kosowski et al (2003) was such study which was helping in the decision of best fit model after reviewing the relevant case. To work on the right course, studies for measuring performance of mutual funds were also important. For this sake, study carried on by Friend et al (1962) is considered. It was carried on by taking the data result of 152 funds between the period of 1953-58 and constructed indexes of standard and poor indexes of five securities. They showed that there is a negative correlation between the variables of measures of management expense and performance of funds. Friends & Vickers (1965) showed that the performance of mutual funds and random portfolio was almost the same and there was

[4]

not much difference between them in terms of superiority. Both of the tools were attracting similar returns almost. Donald & John (1974) elaborated the relation between the objectives of the fund and their tendency of risk & returns. They formed the result that the fund managers in closed ended mutual funds were able to keep the portfolios within stated risks. Moreover Tuan Dinth (2006) discussed the relation between risk and return of the mutual funds. That research showed that higher returns are associated with higher risk e.g. stocks of the company can earn high returns but also involves high risks. The techniques which was used by Sharpe & Treynor was also used by Varma et al (1991) to evaluate the performance of master share between the time period of 1987-1991. They came with the result that the performance of mutual funds was better than the market but it was not as much good as to capital market line. In a study regarding Indian mutual fund industry, Sethu (1999) examined 18 open ended mutual fund schemes between 1985-99 and constructed the results as negative returns. Mahmud et al (2002) based their study to measure the mutual funds performance by the help of lower partial moment tool. They tried to build the measure to evaluate the mutual funds performance by using lower partial moment. In this method risk is taken into account by using the states where return is not up to a targeted rate. Fernandez (2003) had a paper on evaluation of index fund implementation. In that paper, he tracked down the error in measuring the index fund. Pendaraki et al (2005) studies will also be used in which they formulated the construction of portfolios in mutual funds and guided to the development of multi criteria methodology. Their methodology of selecting and composing mutual funds was based on the grouping of both discrete and continuous decision support methods. In their studies, approach of UTADIS multi criteria decision was adopted to make the mutual funds performance model. Another study by Zakri (2005) focused on the difference of qualities regarding nature of assets held, portfolio diversification degree and affects of different variable on the diversified portfolios of stock mutual funds and conventional funds of stock market. The results of the study showed that mutual funds do not have much difference in terms of these characteristics and also the diversification dont affect the performance of the fund a lot. Similarly, Agarwal (2007) took an overview of the mutual funds performance in emerging markets. That study narrated the size of the market and asset allocation

[5]

accordingly. It further described the price mechanism of mutual fund industry with brief explanation regarding empirical relation of all the factors. The good thing about the studies was analysis of data both at investor level and fund manager level. Some studies are also done to evaluate the relationship of open ended funds performance with the characteristics of different time periods of the developed economies. These include Soderlind et al (2000) & Smythe et al (2004) in which the researchers focused of funds performance in context of developed economies. Soderlind et al (2000) shed light on the relation of funds size with its performance in context of Swedish market. Similarly Further some studies were also been conducted to know the relation between funds size and its performance e.g. Robert (1998) carried on the research under said topic and concluded that the efficiency of small funds in terms of performance is greater and he proved his point with the example of superior performance by smallest quartile of US mutual funds in comparison to other funds. The same studies was done by Gorman (1991) earlier and formulated same results that the small mutual funds in terms of net assets performed a bit better than large funds. These studies indicated that economies of scales are not there in case of mutual funds. Its benefits exhaust with the increase of size and it results in lesser returns. The same was affirmed by Becker et al (2001) and Chen et al (2004). Some researchers focus on the consistency of management effectiveness. They evaluated the facts that funds mangers are not able to provide consistent returns on the funds with the effective management. A study of this field was done by Brown (1995), he analyzed the annual fund returns of US mutual funds and found the fact that returns are correlated with time serially and was not linked much with the effective management of funds. Then many studies showed that even actively managed funds were not successful to increase the returns on the fund and so the funds returns are negatively related with funds expense. This was evident from the study of Livingston et al (1998) as they practically demonstrated the significance of expense in open-ended funds. . Friend et al (1970) carried on their study to show the negatively correlated funds performance and funds management expense. They concluded that with the increase in the expense, the returns of the mutual funds were declining. . Conclusion of studies

[6]

by Ippolito (1989) was that in general mutual funds are better in returns if they are not offset by the charges of load and expenses. The same context was tried to prove by Elton et al (1993) . They examined the returns on US mutual funds and concluded that performance of fund was negatively related to the amount of expense of the funds. Some other form of expense like load was discussed by Doroms & Walker (1995) by analyzing the international mutual funds. He used pooled cross sectional model of regression line to know what is the relation among variables i.e. how load or no-load status of funds, size of the asset, ratios of expense and turnover rate is related to un adjusted or risk adjusted returns. The result of the study was that performance was not found to be more different from each other in unadjusted or risk adjusted returns. Another expense was studied by McLeod et al (1995). They analyzed a different form of mutual fund expense which was 12B-1. They concluded that managers justify these expense by giving higher returns. Another aspect related to mutual funds is the level of fund turnover. The level of turnover shows the policies of fund management whether it is actively managed or passively managed. High turnover represents active management of funds else it means that funds are managed passively. This aspect was considered by some

researchers too. Carhat (1997) evaluated these facts and concluded that there is a negative relation in turnover and funds return. On the other hand Soderlind et al (2000) showed positive relation in both variables. They found that the relation between the funds turnover and its return are linear. Glenn (2004) investigated upon the fact that whether greater returns are generated in open-ended mutual funds or closed ended mutual funds. He suggested that as there is room for redemption of shares in openended funds so its the need of open ended funds to keep cash in the form of assets so the amount invested in open ended funds are less and so the returns generated in open ended mutual funds are also on the lower side. Some studies also investigated the variable of funds age to be the important determinant in determining cash flows of the fund, returns on funds, size of it and expenses of the funds. Rao (1996) investigated on the same matter by picking up the sample size of 964 funds from US mutual fund industry. The same topic was touched by another researcher Sawicki et al (2002) to

[7]

analyze the affect of age on the variables of cash flows, returns and expenses of the mutual funds. Due to the increasing importance of investors in mutual funds industry, researchers interest was also developed more in the said field. Ramasamy et al (2003) analyzed the Malaysian economy and features that consistent past performance, funds size and the transactions cost are three major determinants to affect the performance of the fund. Narayan (2003) evaluated the performance of Indian mutual funds performance and concluded that the industry is capable of meeting the expectation of investor but as per Mukul et al (2006), there is a need of more professionalism and better system in the industry. Gurber (1996) claimed that mutual funds on average ha not performed up to the mark based on US data. Otten & Barns (2002) claimed in a research that European mutual fund industry is behind that of US mutual fund industry and has room to add value. Similarly Wermers (2000) says that funds in America outperformed by 1.3 percent. UK mutual funds performance was also investigated by Blake et al (1998) and found that UK fund market is under performing by 1.8 % every year on the basis of risk adjustment. Further Otten (2002) using the international database including data of Germany, US and UK concluded that mutual fund industry is under performing currently and needs adjustments for improvement. Otten et al (2004) also claimed in his work that US mutual funds industry is underperforming by the amount of expense they charge to investors. UK markets mutual fund performance was covered well by Matatko & Corner (1992) on the basis of 15 ethical unit trusts. Research was conducted to know whether mutual funds can manage the turns of the stock exchange. Treynor & Mazuy (1966) tried to investigate on the fact whether the mutual funds can outguess the market of not, and they concluded that there is no evidence that mutual fund can outguess the market. Risk taking by mutual funds was discussed in the working paper of Chevelier & Ellison (1995), in which they said that there is agency conflict between the mutual fund companies and investors of mutual funds. Investors will be more interested in companys action to generate more risk adjusted returns while company will be trying to take action which can attract more inflow of investments. They proved their point by pointing out the fact of changing the

[8]

riskiness position of mutual funds investment between September to December to attract more investors. For measuring the performance of mutual funds Allan (2003) pointed out some methods to evaluate the performance mutual funds and funds manager. This study contains not only performance measurement techniques but also the risk & returns associated with the investment. This includes different tools for assessing returns as respondent to risk appetite of the investor. Further some useful tools such as treynor ratio and CAPM are discussed for performance measurement.

References:
1. Agrawal, D. (2007). Measuring Performance of Indian Mutual Funds. Prabhandan Tanikniqui, 1, 1: 43-52.

2. Bauer, Rob, Keen Koedijk, and Roger Otter (2002) International Evidence onEthical Mutual Fund Performance and Investment Style. ABP Investments Maastricht University, 128.

3. Becker, S. and G. Vaughan (2001), Small is beautiful. Journal of Portfolio Management, pp. 9-17.

4. Blake, David, and Allan Timmermann (1998) Mutual Fund Performance: Evidencefrom UK. European Finance Review 2, 5777.

5. Brown, S. J. and W. N. Goetzmann (1995), Performance persistence. Journal of Finance, Volume 50, pp. 679-699. 6. Carhart, M. M. (1997), On persistence in Mutual Fund performance. Journal

[9]

of Finance, Volume 52, pp. 56-82. 7. Chen, J., H. Hong, M. Huang and J. Kubik (2004), Does fund size erode performance? Liquidity, organizational diseconomies and active money management. American Economic Review, Volume 94, pp. 1276-1302. 8. Fama, E. and French, K. (1992). The cross section of expected stock returns, Journal of Finance, 47, pp 427-465 9. Fama, E. and French, K. (1993). Common risk factors in the returns on stocks and bonds, Journal of Financial Economics, 33, pp 3-56.

10. Fernandes, K. (2003). Evaluating index fund implementation in India. Working paper, http://www.nseindia.com/content/research/Paper66.pdf. 11. Ferson, W. and Schadt, R. (1996). Measuring fund strategy and performance in changing economic conditions, Journal of Finance, 51, pp 425-462.

12. Friend, I. and Vickers, D. (1965).Portfolio Selection and Investment Performance. The Journal of Finance, 20, 3: 391-415.

13. Elton, E., M. Gruber, S. Das, and C. Blake (1996) The Persistence of Riskadjusted Mutual Fund Performance. Journal of Business 69, 133157. 14. Glenn, Brian, Bullrun Financial, Inc., Lawrenceville and Thomas Patrick(2004), The mechanics behind investment funds: Why closed-end fundsprovide superior returns? Managerial Finance, Volume 30, Number 12.

15. Guha, S. (2008). Performance of Indian Equity Mutual Funds vis-a-vis their Style Benchmarks. The ICFAI Journal of Applied Finance, 14, 1: 49-81.

[10]

16. Gorman, L. (1991), A study of the relationship between Mutual Fund returnand asset size, 1974-1987. Akron Business and Economic Review,Volume 22, pp. 53-61.

17. Huhmann, Bruce A. (2005), Does Mutual Fund advertising providenecessary investment information? International Journal of BankMarketing, Volume 23, No. 4, pp. 296-316.

18. Ippolito, R. A. (1992), Consumer reaction to measures of poor quality:Evidence from the Mutual Fund industry. Journal of Law andEconomics, Volume 35, pp. 45-70.

19. Jensen, C. Michael (1968) The Performance of Mutual Funds in the Period 19451964. Journal of Finance 23:2, 389416.

20. Joseph, H. Golec (2004), The effects of Mutual Fund managerscharacteristics on their portfolio performance, risk and fees. FinancialServices Review. 21. Kosowski, R., Timmermann, A., Wermers, R. and White, H. (2001). Can mutual fund stars really pick stocks? New evidence from a bootstrap analysis, Discussion Paper, University of California San Diego. 22. Livingston, M. and E. ONeal (1998), The cost of Mutual Fund distributionfees. Journal of Financial Research, Volume 21, pp. 205-218. 23. Luther, Matatko, and Corner (1992) The Investment Performance of UK EthicalUnit Trusts. Journal of Accounting, Auditing and Accountability 5:4, April.

24. McLeod, R. W. and D. K. Malhotra (1994), A re-examination of the effect of12B-1 plans on Mutual Fund expense ratio. Journal of FinancialResearch, Volume 17, pp. 231-40.

[11]

25. Mishra, B. and Mahmud, R. (2002). Measuring mutual fund performance using lower partial moment. Global Business Trends, Bhubaneswar, India.

26. Narayan Rao and Ravin Daran Madava. (2003), Performance evaluation ofIndian Mutual Funds. Available at SSRN: http://ssrn.com/abstract =433100 or DOI: 10.2139/ssrn.433100.

27. Otten,

Roger,

and

Dennis Economic

Bams Versus

(2004)

How

to

Measure

Mutual of

FundsPerformance:

Statistical

Relevance.

Journal

Accounting andFinance 44, 203222.

28. Pendaraki, K., Zopounidis, C. and Doumpos, M. (2005). On the construction of mutual fund portfolios: A Multicriteria methodology and an application to the Greek market of equity mutual funds. The European Journal of Operational Research, 163, 2: 462-481.

29. Ramasamy, Bala and Mathew C. H. Yeung (2003), Evaluating mutual fundsin an emerging market: Factors that matter to financial advisors.International journal of Bank Marketing, pp.122-136.

30. Robert, T. Kleiman and Anandi P. Sahu (1988), The relationship betweenMutual Fund size and risk-adjusted performance: An analysis of loadfunds. American Business Review.

31. Roger,

Otten,

and

Dennis

Bams

(2002)

European

Mutual

Fund

Performance.European Financial Management 8:1, 75101.

[12]

32. Sethu, G. (1999). The Mutual Fund Puzzle, International Conference on Management, UTI-ICM, Conference Proceedings: 23-24.

33. Soderlind, Paul, Dahlquist, Magnus and Stefan Engstrom (2000),Performance and characteristics of Swedish mutual funds. Quantitative Analysis, Volume 35, No. 3, pp. 409-423. Journal ofFinancial and

34. Sharpe, William F. (1966) Mutual Fund Performance. Journal of Business 39(January), Supplement on Security Prices, 11938.

35. Spuma, M. Rao (1996), Does 12B-1 plan offer economic value toshareholders of Mutual Funds? Journal of Financial and StrategicDecisions, Volume 9.

36. Treynor, J. L. (1965). How to Rate Management of Investment Funds?Harvard Business Review, 43, 1: 63-75.

37. Wermers, Russ (2000), Mutual fund performance: An empiricaldecomposition into stock-picking talent, style, transactions costs, andexpenses. Journal of Finance, Volume 55(4), pp. 1655-1695.

38. Zakri Y. B. (2005). Socially Responsible Investing and Portfolio Diversification. The Journal of Financial Research, 28, 1: 41-57