Performance Evaluation of Mutual Funds in Bangladesh (2000-2009)

Tanzina Hossain

Assistant Professor

Department of Business Administration

Faculty of Business and Economics

DaffodilInternationalUniversity

E-mail:

Cell: 01552-325686

Zinnatun Nesa

Lecturer

Department of Business Administration

Faculty of Business and Economics

DaffodilInternationalUniversity

E-mail: znz17_7@yahoo.com

Cell: 01913510536

Performance Evaluation of Mutual Fundsin Bangladesh

Abstract:

This paper looks at the performance of Bangladeshi Mutual Funds over the last five and ten year periods using Traditional measures, M2 measure, and Quadratic Model analysis. Month-end closing price and dividend data have been collected for two selected periods (2000-09) for 10 funds and(2005-09) for 12 fundsto compute and compare the performance of the Mutual Funds withthat of the DGEN index.The study reveals that almost all of the selected Mutual Funds were performing better where market timing skills were absent for all of the funds.

Key words:Mutual Fund performance; Sharpe, Jensen and Treynor measures ofportfolio performance; M2 measure and Quadratic Model analysis; Market timing skills.

1.0 Introduction

Mutual Funds are now perhaps the most widely known investment schemes around the world. It is of enormous interest not only to researchers but also to investors who are seeking to havea portfolio of securities but face the lack of time or the expertise to manage that. It is relatively an inexpensive way for them to get a full-time manager to make and monitor their investments. But, despite the tremendous interest in Mutual Funds worldwide, from the very beginning, it failed to catch the fancy of Bangladeshi investors.In Bangladesh, for a long time a government backed organization: Investment Corporation of Bangladesh (ICB) was the only player in this game. But, the growth in Mutual Funds and their assets has been one of the important stories in recent years. And it has been able to attract a good number of investors with a substantial amount of investment.There have been many new Mutual Funds whoseformalities with the regulators have already been finished, and many others whose proposals are on the board positively. This is essentially a strong signal for the development of an organic capital market, offering a safe alternative investment avenue for the investors that really can reduce the excessive and aggressive dependence on equity stocks.

Many investors debate whether or not the professionals are better than you or I at picking stocks. Moreover,with several market entrants the question arises regarding the choice of Mutual Funds. In fact, investors need to pay careful attention in choosing to invest through Mutual Funds. So, it is becoming an important issue to investors to evaluate the performance of Mutual Funds in Bangladesh.In this paper we would look at the performance of Mutual Funds in Bangladesh over the last five year and last ten year period using different well known performance measures.

The remaining of the paper is organized as follows: section 2 reviews the literature of Performance Measures, addressing both classic and new measures; section 3 presents a summary of status of Mutual Funds in Bangladesh. Section 4 presents the models used for evaluating the performance of Mutual Funds. Section 5 outlines the methodological issuesrelevant to the theme of the study. Section 6states the limitation of the study whereas current status of Mutual Fund in Bangladesh is outlined in section 7.Section 8 & 9 speak about the models of performance measurements and the methodology of the study respectively. Data and theempirical results are presented in section 10 and 11. Concluding remarks are provided in Section 12.

2.0 Literature Review

Literature on Mutual Funds performance evaluation is enormous. Many researchers have attempted to assess Mutual Funds’ performances over time.Three of the earliest performance measures, still in use today, are the Treynor index (Treynor 1965) of the excess return per unit of the systematic risk, the Sharpe index (Sharpe 1966) of the excess return per unit of the total risk, and the Jensen’s α (Jensen 1968), which is defined as the difference between the actual portfolio return and the estimated benchmark return. Since these pioneer works, numerous studies have been concerned with measuring performance in two dimensions (i.e., risk and return) by relying on the Capital Asset Pricing Model (CAPM). The results of these studies depend, to a large extent, on the benchmark portfolio used, the measurement of the risk, and the main criticism made on the use of CAPM is the validity of its underlying assumptions. A few research studies that have influenced the preparation of this paper substantially are discussed in this section.

Sipra (2006) in his paper looks at the performance of Pakistani Mutual Funds over the 2000-2004 and 1995-2004 year periods. He used Sharpe, Jensen and Treynor measures of portfolio performance analysis where the performance is compared to that of the market portfolio defined as the KSE 100 index. Using the Sharpe measure the performance of virtually all the funds was found to be inferior to that of the market portfolio. The Jensen and Treynor measures showed about half the funds to be outperforming the market portfolio over the 2000-04 years, but when the risk measure was corrected using Fama’s net selectivity measure the market portfolio outperformed all the funds except one.

Kenourgios and Petropoulos(2005)examine the past performances of Mutual Fundsof U.K. stock market as a criterion for investors’ future choices. They start their analysis by calculating the annual returns of all funds and the Jensen’s measure of performance (in the context of CAPM). Moreover, they test persistence by constructing two-way tables showing the successful performance over successive two-year and one year period. They did not include in their sample funds that have ceased to exist or merged or started their operation after 1990 (they do not have complete observations).

Sapar and Madava(2003) evaluated performance of Indian Mutual Funds in a bear market through relative performance index, risk-return analysis, Treynor’s ratio, Sharpe’s ratio, Sharpe’s measure, Jensen’s measure, and Fama’s measure. The study used 269 open-ended schemes (out of total schemes of 433) for computing relative performance index. Then after excluding funds whose returns are less than risk-free returns, 58 schemes are finally used for further analysis. The results of performance measures suggest that most of Mutual Fund schemes in the sample of 58 were able to satisfy investor’s expectations by giving excess returns over expected returns based on both premium for systematic risk and total risk.

Roy and Deb(2003) conducted an empirical study on conditional performance of Indian Mutual Funds. This paper uses a technique called conditional performance evaluation on a sample of eighty-nine IndianMutual Fund schemes.This paper measures the performance of various Mutual Funds with both unconditional and conditional form of CAPM, Treynor- Mazuy model and Henriksson-Merton model. The effect of incorporating lagged information variables into the evaluation of Mutual Fund managers’ performance is examined in the Indian context. The results suggest that the use of conditioning lagged information variables improves the performance of Mutual Fund schemes, causing alphas to shift towards right and reducing the number of negative timing coefficients.

Mishra and Rahman (2002) measured Mutual Fund performance using lower partial moment. In this paper, measures of evaluating portfolio performance based on lower partial moment are developed. Risk from the lower partial moment is measured by taking into account only those states in which return is below a pre-specified “target rate” like risk-free rate. Fernandes(2003) evaluated index fund implementation in India. In this paper, tracking error of index funds in India is measured .The consistency and level of tracking errors obtained by some well-run index fund suggests that it is possible to attain low levels of tracking error under Indian conditions. At the same time, there do seem to be periods where certain index funds appear to depart from the discipline of indexation.

Pendaraki, Zopounidis, and Doumpos(2005) studied construction of Mutual Fund portfolios, developed a multi-criteria methodology and applied it to the Greek market of equity Mutual Funds. The methodology is based on the combination of discrete and continuous multi-criteria decision aid methods for Mutual Fund selection and composition. UTADIS multi-criteria decision aid method is employed in order to develop Mutual Fund’s performance models. Goal programming model is employed to determine proportion of selected Mutual Funds in the final portfolios.

Chen and Jang (1994) evaluate the performance of 15 U.S.-based international Mutual Funds for the period 1980-89. The technique used here is the one developed by Treynor and Mazuy and refined by Lee and Rahman. Here they find that many of the international Mutual Funds outperformed the U.S. market benchmark and when a world market index is used as the benchmark, fund managers show relatively poor performance in terms of selectivity skills. However, there is strong evidence that some managers rely rather heavily on timing skills in international capital markets.

Zakri Y.Bello (2005) matched a sample of socially responsible stock Mutual Funds matched to randomly selected conventional funds of similar net assets to investigate differences in characteristics of assets held, degree of portfolio diversification and variable effects of diversification on investment performance. The study found that socially responsible funds do not differ significantly from conventional funds in terms of any of these attributes. Moreover, the effect of diversification on investment performance is not different between the two groups. Both groups underperformed the Domini 400 Social Index and S & P 500 during the study period.

3.0 Objectives of the Study

The purpose of this paper is to evaluate the performance of Mutual Fund sector of Bangladesh.Specifically the study is aimed at: (i) presenting the overall status of Mutual Funds in Bangladesh (ii) assessing the past performance ofMutual Funds(iii) helping the potential investors for assessing the investment decision.

4.0 Significance of theStudy

Several studies have been conducted based on the performance of Mutual Funds around the world. However, no such study has been seen in Bangladesh. This study would be beneficial for the investors as well as the policy makersof Mutual Funds in Bangladesh in taking decision whether to invest directly or indirectly.

5.0 Scope of theStudy

There are lots of scopes for improvement in the research for performance evaluation of Mutual Funds in Bangladesh. Various other multi-criteria decision models could be tested for evaluating Mutual Fund performances. Testing of fund performances in the long run withextended sample of Mutual Fund can be done in futurefor generating more reliable results.

6.0 Limitations of theStudy

Sample size is the major limitation of this study. Required sample could not be availed of due to unavailability of enough number of funds existing for 10 or 5 year periods to be applied to evaluate the performance of Mutual Funds. If a reasonable number of samples were analyzed, the paper could have a more accurate analysis. We have considered here 28-day Treasury bill rate as the risk-free rate which is considered as the risk-free rate usually in terms of performance analysis. This is another limitation because inactive Treasury bill market in Bangladesh does not represent risk-free compensation for the investors properly. Moreover, our capital market is an emerging one with tiny Mutual Fund industry. So the various financial analyses can not be applied to judge the performance of Mutual Fund.

7.0 Status of Mutual Funds in Bangladesh

There is a very small market for Mutual Funds having low issued capital in Bangladesh where Mutual Funds fall into two categories: open-end funds and closed-end funds. Among 24 closed-end Mutual Funds listed in DSE, eight are managed by the Investment Corporation of Bangladesh (ICB), eight by ICB Asset Management Co. Ltd. (a subsidiary of ICB), one by Bangladesh Shilpo Rin Shangstha (BSRS) and the remaining seven are managed by the private sector. All of the funds issued in Bangladesh up to 2009 do not commensurate properly to the theoretical framework of Mutual Fund. Notionally, Mutual Fund is formed and operated like a company where shares are issued to investors to raise fund for the investment in different sectors, comprising money market and capital market. But in Bangladesh for the Mutual Funds from 1st ICB to 1st BSRS, various outstanding investments of the ICB were converted into different schemes and came to the market in the form of Mutual Fund through the issuance of shares to general investors. This was an off the cuff step with the purpose of creating a Mutual Fund market in the country. These funds have been listed separately in appendices (table 12) to present the overall status of Mutual Fund industry in Bangladesh. So far all the Mutual Funds have been issued at face value, price of Mutual Fund certificates after IPO is determined on the Stock Exchanges through interaction of supply and demand. Theoretically the price of a Mutual Fund certificate can change daily. There are also three open-end Mutual Funds of which one is managed by ICB and the other two are by ICB Asset Management Co. Ltd.

Year end Key statistics of closed-end Mutual Funds from 2007 to 2009 are given in appendices (table1 to table 4). From 1st ICB to 1st BSRS Mutual Fund (Appendices; Table 1) market value has increased from 2007 to 2008 and from 2008 to 2009 with the exception for 4th ICB Mutual Fund in 2008(90.71% decrease in market value). Among the Mutual Funds in table 1, the same fund has experienced the highest price hike in 2009 in comparison to 2008. For Aims First to ICB AMCL Mutual Fund (Appendices; Table 3) largest change(33.39% decrease) in market value is present for Grammen Mutual Fund,Scheme two in 2009 from 2008. Both the EPS and DPS remainedsame for all the funds, from 1st ICB to 1st BSRS Mutual Fund (Appendices; Table1). The P/E ratio for all funds is ranging from 10% to 40 % and the same picture exists for the ratio of market price to NAV; funds were traded at an average of 3.75 times to their net asset value (NAV) where all of which ultimately resembles the growing demand of Mutual Fund in the market(Appendices; Table 2).

For the funds inappendices (table 3) the DPS and EPS both have kept changing with an increasing trend for the years presented. The P/E ratio for all funds is ranging from 5% to 93 % and the ratio of market price to NAV is on an average 3.5(Appendices; Table 4). It is evident from the tables that most of the Mutual Funds are passing an increasing trend in market value but some funds (ICB AMCL Islamic MF decreased 15.63%,ICB AMCL First NRB MF decreased 19.35% in 2008)

The price-earning ratios show some excess in 2009 compared with the end of 2008 for all listed Mutual Funds ranging from 15.22 to 95.69 (specially for the funds from ICB to BSRS)mainly due to price augmentation of Mutual Funds. The picture is same for the ratio of market price to net asset value (NAV) of all Mutual Funds in December 2009.

Although ICB is the major institutional player in the Mutual Fund market, the newly entered privately managed Mutual Funds are performing relatively well in the capital market which owns the highest share in terms of market capitalization among the issuers for the year 2009 (see figure-1). The market prices of all Mutual Funds remain much higher than their face values reflecting the investors’ confidence and their expectations of future price hikes. The reason is that, all the earlier Mutual Funds were very small in size. Hence, the number of funds may be more for ICB, but funds size is very small.

Figure1: Issuer wise Market Capitalization for the year 2009

In Bangladesh perspective, the number of Mutual Fund is growing gradually as at the IPO phase investors are profiting well. Since, investors are quite impressed by the marginal performance of the Mutual Funds; they feel interest to put money in them in the secondary market. Therefore, the consequence is clear. An emerging secondary market for Mutual Funds has been encouraging investors of taking advantage properly, and thus making more and more investors positive towards them. However, this small market of Mutual Funds is not happy at all at this moment. A very serious but interesting debate has been looming for last few months regarding Mutual Funds in Bangladesh. The SEC implemented revised Mutual Fund regulations on July 22, 2009 that prohibited the closed end Mutual Funds from increasing the size of Mutual Funds through right or bonus shares to increase their capital bases. After the writ petition from investors against this amendment, The High Court on November 09, 2009 allowed Mutual Funds to raise their size by issuing bonus and rights, without curbing the securities regulator's absolute power to determine which funds would be eligible to expand the capital base although this verdict was suspended hours after the announcement giving the SEC adequate time to appeal. (Barua, 2009)