Reddy Funds

Scope of Mutual Funds has grown enormously over the years. In the first age of mutual funds,when the investment management companies started to offer mutual funds, choices were few. Even though people invested their money in mutual funds as these funds offered them diversified investment option for the first time. By investing in these funds they were able to diversify their investment in common stocks, preferred stocks, bonds and other financial securities. At the same time they also enjoyed the advantage of liquidity. With Mutual Funds, they got the scope of easy access to their invested funds on requirement. But, in todays world, Scope of Mutual Funds has become so wide, that people sometimes take long time to decide the mutual fund type, they are going to invest in. Several Investment Management Companies have emerged over the years who offer various types of Mutual Funds, each type carrying unique characteristics and different beneficial features. To understand the broad scope of Mutual Funds we need to discuss the main types of Mutual Funds that are normally offered by the Mutual Companies.

PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003-2008 BY SHANTANU RAIZADA 2008 A dissertation presented in part consideration for the degree of ‘MA in Finance and Investment’. PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 Page 2 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008

ABSTRACT

Many studies have been conducted in the past on the performance of Mutual Funds in comparison to the market index. These studies may differ in their time period, but most of them concluded that on an average the Mutual Funds failed to outperform the market thus the Efficient Market Hypothesis holds good. This

research was based on the performance of 20 open ended equity diversified growth Mutual Funds for a period of 5 years from April 2003 to March 2008 and was compared to the BSE 500. Funds were evaluated using Sharpe Ratio, Treynor Ratio, Jensen’s alpha etc. The results were quite significant and different from the past studies. It was concluded that more than 75% of the funds outperformed the market and delivered positive returns. Page 3 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008

ACKNOWLEDGEMENTS

I would like to take this opportunity to thank my supervisor Mr. Scott Goddard for his help and support throughout. I am very grateful to him for showing so much confidence in me. I would further like to thank my family and friends for their love and support. Page 4 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008

Table of Contents

Chapter 1 Introduction 1.1 Concept of Mutual Fund 11 1.2 Types of Mutual Fund 13 1.3 Frequently Used Terms 16 1.4 Advantages of Mutual Funds 17 1.5 Disadvantages of Mutual Funds 19 1.6 Organization of Mutual Fund 20 Page 5 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 Chapter 2 Mutual Funds in India 2.1 History 24 2.2 Future of Mutual Funds in India 27 Chapter 3 Investment Theories 3.1 Modern Portfolio Theory 30 3.2 Capital Asset Pricing Model 33 3.3 Efficient Market Hypothesis 37 Chapter 4 Literary Review 4.1 Performance Measures of Mutual Funds 39 4.1.1 Sharpe’s Measure 39 4.1.2 Jensen’s Measure 41 Page 6 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 4.1.3 Treynor’s Measure 42 4.1.4 Appraisal Ratio 44 4.2 Past Performance of Mutual Funds 45 Chapter 5 Data Description and Methodology

5.1 Sources of Data 50 5.2 Stock Market Index 51 5.3 Net Asset Value 52 5.4 Return 52 5.5 Geometric Mean 53 5.6 Risk 53 5.6.1 Total Risk 53 5.6.2 Systematic Risk 54 Page 7 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 5.6.3 Non Systematic Risk 55 5.7 Sharpe Ratio 56 5.8 Treynor’s Measure 57 5.9 Jensen’s Measure 57 5.1 0 Appraisal Ratio 58 5.1 1 Linear Regression 58 Chapter 6 Analysis and Interpretation of Data 6.1 Beta 65 6.2 Sharpe Ratio 65 6.3 Treynor Ratio 66 6.4 R2 66 6.5 Jensen’s Alpha 66 Page 8 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 6.6 Information Ratio 67 6.7 Limitations of the Study 67 Chapter 7 Conclusion 7.1 Recommendations for Future Research 77 References 78 Page 9 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008

Chapter 1

Introduction The financial world is an extremely complex, growing and changing field. With millions of investment choices today it’s difficult for an average investor to begin investing. Mutual Funds are the most common investment vehicles that allow investors to achieve greater diversification with minimal investment capital and cost. Stock market trading has increased and has become more than an investment option for many Indians. The Indian economy with its development and modernization has created tremendous opportunities for every individual to

grow and prosper. All this has led to a new phase of development in the Indian stock market and has increased the investment opportunities for the common man as well. India being a favourable destination for expansion in terms of manufacturing, retail, IT etc has attracted a lot of FDI and attracted even more foreign investors to invest in the Indian stock market. With the advancement in investment mechanisms it has led to a major change in the attitude of Indian investors. Savings form an important part of the economy and earlier the Indian financial scene represented savings mostly in the form of fixed deposits with nationalised banks. The situation changed and people started investing more in financial markets, though not directly but through the help of Mutual Funds. It may not be that the Indian market is the safest and best market in the world but the rate at which this market is growing provides us with very good returns. Although a small amount of people do invest directly in the capital market but the major problem is that of expertise. While investing directly one has to be smart enough to judge the securities and understand its complexities. This becomes very difficult for investors with small means to keep a track of the market and continuously follow up. This is where Mutual Funds play an important Page 10 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 role. Outsourcing this job to experts who scrutinize every security and continuously follow up solves the problem for these small investors. Mutual Fund is a nothing more than a collection of stocks and/or bonds. It’s a trust that pools the savings of a number of investors who share a common financial goal of increasing return and decreasing risk. Mutual Fund is a company that brings together a group of people and invests their money in stocks, bonds and other securities. These companies are also called Asset Management Companies (AMC) which is a part of bigger financial institutions like banks etc. Trading in stock market has increased substantially and due to that it has led to an increase in investment opportunities for the general public. Due to recent developments India has attracted more and more foreign investors to invest in its markets. The main purpose of this dissertation is to compare the performances of Mutual Funds with the stock market index. For this purpose I have selected 20 open ended equity diversified growth Mutual Funds and collected their monthly NAV’s from the time period April 2003 to March 2008. This data is then compared to the

BSE 500 and results are then drawn. The 20 funds used consist of both top performing and laggard Mutual Funds thus giving us a concrete sample. This study applies modern theories of portfolio performance measurement and evaluates the performance of Mutual Funds during the past 5 years.

1.1 Concept of Mutual Fund Mutual Fund is a trust that pools money from a group of investors who have a common financial goal and invest the collected funds into different asset classes which match the objectives of the scheme. A Mutual Fund cannot deviate from its goal as its objectives are the basis on which it collects funds from investors. Page 11 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 Every Mutual Fund has a fund manager who uses his skills to ensure a higher return then what the investor can manage on its own. The returns generated in the form of capital appreciation and other incomes in forms of dividends are distributed to its investors or unit holders in proportion to the number of units they own of that fund. (www.appuonline.com) Source-www.kotakmutual.com The type of Mutual Fund to invest in depends upon the characteristic s of the investor. Investment strategies would be different for a risk taking investor and different for a risk averse investor. Every Mutual Fund has an objective. The objectives are further broken down into specific goals like growth, income or stability. Growth means increase in value of the amount invested. Income is return in form of interest or dividends and stability means protection from loss and protection from variability in price change of shares. (Cavanagh) Page 12 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008

1.2 Types of Mutual Funds in India Broadly Mutual Funds are of three types depending upon their structure and objectives. These funds can be classified as follows• By structure 1) Open- ended schemes. 2) Close-ended schemes. 3) Interval schemes. • By objectives 1) Growth schemes. 2) Income schemes. 3) Balanced schemes. 4) Money market schemes. • Others 1) Tax saving schemes. 2) Special schemes o Index schemes. o Sector specific schemes. Page 13 of 91

PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 Open ended schemes- this type of Mutual Fund is a fund that does not have a set number of shares. It is available for subscription all through the year. These funds do not have a fixed maturity. It continues to sell shares to investors and buy’s it back from them whenever investors wish to sell it. Units are bought and sold at their current NAV which is declared on a daily basis. The key feature of such funds is the liquidity factor. Close ended schemes- this type of Mutual Fund has a set number of shares issued to the public through a new fund offer. This fund is open for subscription only during a specific period of time i.e. the corpus remains unchanged at all times. Either the investors can invest in the scheme when the initial offering is there or buy the units of the scheme through the stock exchange. The units of these schemes are traded on the stock exchange like other securities. Buying and redemption directly from the fund is not allowed. To protect the interest of investors, SEBI provides investors with two avenues for liquidationo These funds are listed on the stock exchange where investors can buy/sell units amongst each other. The trading is generally done at a discount to the NAV which is determined weekly. o These funds may also offer to buy back the units from the unit holders. In this case the corpus of the fund and its units do not get changed. Growth schemes- these funds invest for capital appreciation with a time horizon of 3 to 5 years. They attempt to maximise long term appreciation of the shares they invest in. These funds generally invest in companies that are expected to outperform the market in the future or companies which are experiencing significant growth or revenue. These funds are more volatile as their managers take more risk thus these are not suited for risk averse investors. Page 14 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 Income schemes- these funds invest in those securities which promise a high return in form of cash dividends or coupon interest so as to maximise the recurring income of the investor. To maintain this level the fund managers avoid investing in risky stocks and concentrate on fixed income securities like bonds, preferred stocks and blue chip stocks. Although they are less risky then equities, they are subject to credit risk by the issuer at the time of payment. To minimize this risk fund managers invest in securities from issuers which are rated high by credit rating agencies. Balanced schemes- these funds include assets like debt securities, convertible securities, shares etc which are all held in a equal proportion so as to provide both income and capital appreciation to the investor. The main

objective of a balanced fund is to reward the investor with a regular income and capital appreciation at the same time. Such investment strategies ensure that these funds will manage downturns in the stock market without much loss. These funds are appropriate for investors who are conservative and have a long term horizon. Money market schemes- these funds are also known as liquid funds. They invest in short term interest bearing debt instruments. The major investments in these funds are of Treasury bills other than that are commercial papers and certificate of deposits. These securities bear very little risk and are the safest and the most secure investment. These securities are highly liquid and provide a great deal of safety. Tax saving schemes- these funds offer tax rebates to the investor under specific provisions under Income Tax Act’1961 offered by the government. These schemes are mainly growth oriented funds and invest in equities. E.g. equity linked savings scheme and pension schemes offer tax benefits. Page 15 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 Index schemes- these funds try to match the performance of a specific stock market index. The portfolio of these companies matches those companies which are a part of some index. They try to reproduce the performance of the index. These securities invest in the securities in the same percentage as the index. The NAV’s of such funds move in the same way as the market index. Page 16 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 Sector specific schemes- these funds concentrate only on one sector and restrict their investments to that sector only. The exposure is limited to one sector like information technology, health care, pharmaceuticals, infrastructure etc. The main idea behind this fund is that it allows the investors to invest in specific sectors which they think are growing.

1.3 Frequently Used Terms o Net asset value (NAV) - NAV determines the price paid per share when buying or the price received when selling a Mutual Fund unit. In the case of a load fund the purchase price is the NAV per share plus the load. When selling the price which is received is NAV per share minus redemption fees. NAV= Fund Assets – Expenses and Liabilities No of shares outstanding o Sale price- this is the price paid for the purchase of a unit of a Mutual Fund. It may include a sales load. o Repurchase price- this is the price at which close ended Mutual Funds repurchases its units and it may include a back end load. o Redemption price- this is the price at which open ended Mutual Funds repurchase their units. o Sales load- this is a charge collected by the fund when it sells its units to the investor’s. It’s also called front end load and such schemes are referred to as load schemes. In other words this is the amount which one pays while buying the shares in a Mutual Fund. This charge is also

known as “front -end load”, this fee typically goes to the brokers that Page 17 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 sell the fund’s shares. Front end loads reduce the amount of your investment. E.g. - if we invest 2,000$ and want to invest it in a fund with 5% front end load. Then 100$ sales load will be paid on the top and only the remaining 1,900$ will be invested in the fund. o Back end load-this is a charge which is collected by the fund when it buys back its units. This is also known as purchase fee. However this is different from front end load as this is paid to the fund directly and not to the broker. (www.sec.gov)

1.4 Advantages of Mutual Funds o Diversification of portfolio- Mutual Funds invest in a well diversified portfolio of securities which helps the investor to hold a wide variety of stocks which may otherwise may not be possible. An investor with a mere investment of Rs 5,000 can own shares of a blue chip company; this is only possible through a Mutual Fund. Thus it enables people with small as well as large means to invest jointly in the fund. Apart from this a normal investor applying for a stock of a company may or may not get it. However if a Mutual Fund applies for the same stock then there’s a sure shot chance for the fund to get the allotment. Later on these shares are sold to the promoters of the company thus it creates investor confidence. o Professional management- Mutual Funds are governed by fund managers which are professional in their field. They undergo thorough various researches and have expert knowledge about market timing, stock selection, risk exposure etc. A common man would not have such Page 18 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 expertise and would face difficulties. The fund managers have proper knowledge and teams which have all such information ready. o Lower transaction cost- investment in mutual find turns out to be cheaper as compared to direct investing. It is estimated that the Mutual Fund expenses are 1.5% of the total investment. Thus investing in Mutual Funds can save a lot of money for the investor in terms of brokerage and commissions. o Less risk- people investing in Mutual Funds acquire a diversified portfolio. The risk level is comparatively low as the risk is hedged. o Choice of schemes- nowadays there are different Mutual Funds available in the market. The investor can choose from a wide variety of Mutual Funds depending upon his attitude towards risk and return. o Liquidity- there is no fixed time period in a Mutual Fund. The investor can exit whenever he wants to by selling his share. Thus there is liquidity in Mutual Funds and as compared to other investment options like fixed deposits or provident funds. o Transparency- Mutual Funds are subject to rules and regulations from the government so that the investors are protected against fraud. The investment company issues periodic statements so that investors can keep a proper track. Thus there is transparency in their operations. o Tax advantage- Mutual Funds are beneficial from the tax point of view as

compared to other investment tools. These funds provide a protection to investors in the form of tax relief under Section 80 L of the Income Tax Act’ 1961. Apart from this there are some other schemes which provide tax Page 19 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 relief under Section 88, thus this leads to the importance of Mutual Funds with the investors. o Increase in FDI- due to increase in Mutual Funds the flow of FDI in the economy increases and this secures more profitable avenues abroad through domestic savings by opening up of off shore funds in other foreign investors. o Forced saving- all dividends and capital gains earned on the Mutual Fund are automatically invested back in the fund and are not used up by the investor. This is a form of forced saving and makes a big difference in the long run. Page 20 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008

1.5 Disadvantages of Mutual Funds o Fees and commission- every Mutual Fund charges an administrative fee to cover their day to day expenses. Apart from this they may also charge a commission on sales which is referred to as sales load. All these costs are born by the investor. o Difficulty in selection- due to a wide variety of Mutual Funds available in the market it may cause confusion among investors as to which fund is to be selected. Often this may result in a wrong choice by the investor. Thus special care and advice needs to be taken in order to select the suitable fund. o Management risk- no investment is risk free. Thus when investors invest in the fund they have to depend upon the managers abilities to get the desired return. A wrong decision may hamper the growth of the entire fund. These Mutual Funds are externally managed and have no employees of their own. There are multiple regulations supervising the Mutual Funds in India. UTI is governed by its own regulations; the banks are supervised by the RBI whereas the central government and insurance company are governed by the central government. o Less popularity- investment in Mutual Funds in India is treated as a substitute for fixed deposits. Around 75% of the investors do not prefer to invest in Mutual Funds unless they are guaranteed a fixed return. o Lack of Uniformity- although Mutual Funds are formed as trusts and the roles of sponsors, trustees, AMC etc are clearly defined still the trustees act as fund managers instead of AMC’s. Apart from this investors are mostly unaware of information regarding their money invested. Although Page 21 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 they have a right to know where their money is being invested and even the Asset Management Companies have an obligation to inform them, still investors are left deprived of the information. o Lack of efficiency- the Mutual Funds management is not very efficient in despatching of certificates, attending to inquiries, repurchasing etc. Thus it leads to a loss in interest of the investor towards the fund.

(Tripathy 1996)

1.6 Organisation of Mutual Funds Securities Exchange Board of India (SEBI) regulations 1996 regulates the structure of Mutual Funds in India. All Mutual Funds in India are created under the Indian Trusts Act’1882. This trust is created by a sponsor and the sponsor will make the initial contribution and appoint trustees to hold the assets of the trust for the benefit of the unit holders. These unit holders are the beneficiaries of this trust. Further on the trustees appoint Asset Management Company as an investment manager to manage the assets of the trust. Further on it’s the job of the AMC to invite investors with different schemes and lure them to contribute to the fund. The AMC is responsible for managing the day to day affairs of the fund. Page 22 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 Source-www.mutualfundsindia.com Page 23 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 From the above the Mutual Fund has the following structure• Sponsor. • Trustee. • Asset Management Company. • Custodian. • Sponsor- as per SEBI guidelines a sponsor is a person who either himself or in an association with another body establishes a Mutual Fund. The sponsor creates a public trust, appoints trustees with the approval of SEBI, creates an AMC under Companies Act’1956 and appoints and registers the trust as a Mutual Fund with SEBI. • Trustee- trustees are responsible for managing the trust. They are responsible to the investors and take care of their interests. They can either be formed as a Board of Trustees (governed under provisions of Indian Trust Act’1882) or as a trustee company (governed under provisions of Indian Trust Act’1882 and Companies Act’1956). The trustees ensure that the activities of the fund are in accordance with the SEBI regulations’1996, they ensure that the AMC has proper systems and procedures in place and due diligence is exercised by the AMC in appointment of associates and partners. Trustees are responsible for the activities of the AMC to SEBI and have to furnish a half yearly report stating the activities of the AMC to SEBI. Trustees are responsible for Page 24 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 approving of the schemes floated by the AMC’s and ensuring that the net worth of the AMC’s is in accordance with the SEBI guidelines. Page 25 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008

• Asset Management Company (AMC) - it’s a company registered under the Companies Act’1956 created by the sponsor for managing the funds of the trust. A small fee is paid to the AMC for the management of the fund. AMC’s can be divided into three parts1. Bank sponsored. 2. Institutions. 3. Private sector. However there are many restrictions on the activities of the AMC. An AMC is restricted to undertake any other business activity other than portfolio management, management and advisory services to offshore funds etc. Apart from this the AMC cannot invest in its own schemes unless and until and until full disclosure has been made earlier. • Custodian- the custodian is responsible for keeping the securities which are in material form safe. The custodian is responsible for ensuring that the delivery of the securities has been done and they are transferred to the respective Mutual Fund. They are responsible for maintaining the account of the Mutual Fund and collect and account the dividends or interest received on the securities held by the fund. They also keep a track of the various announcements, bonus issue, buy back offers etc. (Kaushal Shah and Associates) Page 26 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 This paper is divided into the following chapters• Chapter two deals with the overview of Mutual Funds in India. It discusses the history of Mutual funds in India and the future prospects of the industry as a whole in India. This chapter mentions the various phases of the growth of Mutual Fund industry and also discusses the recent trends in the industry. It further states measures and steps that can be taken to improve the Mutual Fund industry • Chapter three would focus on the basic investment theories like the Modern Portfolio Theory, Capital Asset Pricing Model and the Efficient Market Hypothesis. • Chapter four is divided into 2 parts. The first part states the different performance measures used like Sharpe’s Ratio, Treynor’s Ratio, Jensen’s Alpha and Information Ratio. Whereas the second part depicts the past researches done by scholars on this topic. • Chapter five deals with the data description and methodology used for the research. This chapter discusses methods to calculate returns, performance measures like Sharpe Ratio, Treynor Ratio, Jensen’s Alpha etc. • Chapter six deals with the analysis and interpretation of the research. It interprets the results and findings of the research. Apart from this it also states the limitations of the research. • Chapter seven is the conclusion of the dissertation. Page 27 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008

Chapter 2 Mutual Funds in India

2.1 History The Mutual Fund industry in India was established in 1963 with the formation of Unit Trust of India (UTI) with the joint efforts of the Government of India and the Reserve Bank of India (RBI). The history of Mutual Funds can be broadly divided into four distinct phases.

First phase-1964-1987 UTI was established in 1963 by an act of the Parliament. It was setup by the RBI and was governed under the regulatory and administrative control of the RBI. In 1978 UTI was de-linked from the RBI and the Industrial Development Bank took over in place of the RBI. The first scheme launched by the UTI was Unit Scheme in 1964. By the end of 1988 UTI had Rs 67 billion worth of assets under its management.

Second phase-1987-1993 The year 1987 saw the entry of non-UTI, public sector Mutual Funds setup by public banks like State Bank of India (SBI), Punjab National Bank (PNB), Bank of Baroda etc and state owned insurance companies like Life Insurance Corporation of India (LIC) and General Insurance Corporation of India (GIC). The first nonUTI Mutual Fund was by SBI which was established in June 1987 which was further followed by other non-UTI Mutual Funds setup by public banks. By the end of Page 28 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 1993 the Mutual Fund industry had Rs 470 billion worth of assets under its management.

Third phase-1993-2003 The year 1993 saw the entry of private sector Mutual Funds which gave the investors a wider choice of investment opportunities. In this year the Mutual Fund regulations was enforced under which all Mutual Funds were to be registered except UTI. The first private sector Mutual Fund was Kothari Pioneer in July 1993 which later merged with Franklin Templeton. By the end of 2003 the total assets under the Mutual Fund industry were Rs 1218.05 billion where as the share of UTI was Rs 445.41 billion.

Fourth phase-2003 onwards UTI was bifurcated into two separate divisions. One is the specified undertaking

of the UTI which broadly represent the assets under US 64 schemes, assured return and other schemes. This division operated under the rules and regulations framed by the Government of India and do not come under the Mutual Fund regulations. The other division being the UTI Mutual Fund Ltd which was sponsored by the private banks and this industry along with other funds is governed under the SEBI Mutual Fund Regulations 1996. (www.amfiindia.com) Page 29 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 Source- amfi investor’s guide Page 30 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 Source- www.amfiindia.com Page 31 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008

2.2 Future of Mutual Funds in India India is the third largest Asian economy after Japan and China and twelfth largest in the world. The future of Mutual Funds in India is quite bright. Mutual Funds are one of the most popular forms of investments as these funds are diversified, professionally managed and provide liquidity. Investors with small means can invest in these funds and be part of the market. In the previous six years the growth rate has been 100%; also there have been many foreign asset management companies which have ventured into Indian capital market. The Mutual Fund industry has been expanded to include commodities. In the year 2004 the Mutual Fund industry was worth Rs1, 50,537 crores and it’s expected to grow at a rate of 13.4% over the next 10 years and its estimated that it will touch Rs 40, 90,000 crores by the end of 2010. According to Mr UK Sinha chairman of CII Mutual Fund Summit 2008 and CMD, UTI Asset Management Company, the Indian Mutual Fund industry has grown at compounded annual growth rate of 47% between 2003 and 2008 which comes only next after Russia (97%) and China (67%) during the same time period. Page 32 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 Source-BCG analysis India being a vast country with a large population base, still only 1.6% of the working population aged between 18 and 59 invest in Mutual Funds. Out of 321 million of this work group the investing population is very small thus it’s clearly visible that more than 90% of the people have no clue about a Mutual Fund. In United States of America 43% of the households invest in Mutual Funds whereas in India only 4% invest in Mutual Funds. If we want Mutual Fund industry to scale new heights we should develop a proper investor base and distributor’s guidance. Thus taking advantage of such a base the Mutual Fund industry has tremendous scope to expand in times to come. India has a saving rate of over 23% which is highest in the world. We need to channelize the resources in the right direction. The industry should expand to rural sectors as well, more emphasis should be laid on B and C class cities, and the number of Mutual Funds should be increased.

Mutual Funds have become an important part of the Indian Capital Market and attract a lot on investment and competition. The following are some suggestions if followed it would increase the scope of Mutual Funds. • All Mutual Funds should be governed by a uniform law and it should come under the jurisdiction of a single body. • Indian investors have a preconceived notion that every investment in the market should be like fixed deposits and offer a minimum return. They should be educated and informed that Mutual Funds are subject to market risk and cannot offer a minimum return. Page 33 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 • Mostly only public sector operates in the Mutual Fund market. This should be opened for private sector as well. This would increase competition and prove beneficial to the investor. • Clear demarcation should be made within the structure of the Mutual Funds i.e. the roles of the trustees, sponsors, AMC’s etc should be well defined and followed. • The funds should make true and fair disclosure of all information pertaining to the investments they make so that the investors are not misled and they are fully aware of the type of risk they are undertaking. • Mutual Funds need to develop themselves with the latest technology and take advantages of computer, telecommunications etc for providing service to the investors. Page 34 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008

Chapter 3 Investment theories

3.1 Modern portfolio theory Risk is an inherent part of any investment. No investment is there without risk. Risk and return are directly related as return increases risk increases. Diversification strategy can be used to reduce risk to a great level. One can invest in different securities of different sectors to reduce the level of risk. However even extensive diversification cannot eliminate risk. There are certain factors which affect all firms this is called market risk. This risk cannot be eliminated whereas unique risk which is specific to a certain security can be eliminated through diversification. Harry Markowitz (1952), a pioneer of portfolio analysis, introduced the Modern Portfolio Theory also known as Portfolio Theory or Portfolio Management Theory which later paved the way for his noble prize in economics in the year 1990. His model was the stepping stone in portfolio management which deals with identification of the efficient set of portfolios and is often referred to as the efficient frontier of risky assets. This theory suggested that the standard

deviation or variance and the return are the two most important measures for the selection of a portfolio. This theory drew attention to the fact that an investor can reduce the standard deviation of a portfolio by choosing stocks which are not related to each other or do not move exactly together. This theory further suggests that for any risky level we are only interested in that portfolio which offers us the maximum return. Before the introduction of MPT investors used to select stocks following the rule of Expected Return Maximization which stated that the optimal portfolio is one that offers the highest return. Markowitz further Page 35 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 explained the expected return – variance (E-V) rule and explained the importance of diversification of a portfolio. But the main drawback of his theory was that he did not suggest the number of securities that a portfolio should hold nor did he suggest a method for security analysis. The expected return of the portfolio can be calculated with the weighted average of the expected return of individual securities. The weights assigned to each security or asset is its market value in the portfolio to the market value of the total portfolio. Where, - The expected return of the portfolio. - The expected return of stock ‘I’ of the portfolio. - Weight of stock ‘I’ in the portfolio. Due to this theory it is possible to differentiate between an efficient portfolio and an inefficient portfolio. An efficient portfolio will give higher returns for a lower standard deviation whereas an inefficient portfolio will be the opposite. Page 36 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 Source- Class Notes Prof Shahid Ebrahim, University of Nottingham 2008. The above figure represents the minimum variance frontier of risky assets. The variance frontier is a graph of the lowest possible variance that can be achieved for a given portfolio expected return. All individual assets lie on the right hand side of the efficient frontier thus portfolios which only have those assets would be inefficient. Diversifying investments leads to portfolios with higher return and lower variance. The efficient frontier would be the curved line above the dotted line. This is because all portfolios lying on that portion of the frontier would

provide the best risk-return combinations and are the optimal portfolios. Any portfolio lying below the efficient frontier has a similar portfolio with a higher return and same variance directly above it. Hence the bottom part of the frontier in inefficient. Page 37 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008

3.2 Capital Asset Pricing Model (CAPM) This model is a set of predictions concerning equilibrium expected returns on risky assets which reveals the relationship between risk and return of a security and gives us a way to calculate the expected return of a security. The base for CAPM was laid down by Harry Markowitz in 1952, twelve years later CAPM was developed by William Sharpe, John Linter and Jan Mossin. CAPM is based on certain assumptions which are as follows• The number of investors is very large each having wealth which is small compared to the wealth of all investors. All investors are price takers which means that they act as if the prices of securities are unaffected by their own trading. Thus there is perfect competition in the market. • The time period taken into consideration by the investors is short term. They are short sighted and ignore everything that might happen after the end of the stipulated time period. In other words the behaviour of the investor is myopic in nature. • The investment is only dedicated to publicly traded financial assets. Investments in other fields like human capital, social assets like halls, roads, parks, airports etc are ruled out. Apart from this the investors is free to borrow or lend any amount of money at a fixed rate of interest. • Investors are not subject to payment of any taxes on returns or transaction cost on trading of securities. This is however not possible in reality as payment of taxes and transaction cost is a legal formality. • All investors are rational mean variance optimizers in other words they all use Markowitz portfolio selection model. Page 38 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 • Al investors analyze the securities in the same way as others and have the same information which is available to others. This means that for any set of security prices they all derive the same input list for the model. In other words all investors have homogenous expectations. These assumptions ignore many of the real world complexities; if they are met then this model can be used to gain powerful insights into the nature or equilibrium in security markets. The following implications would be explained• All investors would hold a similar portfolio of risky assets as compared to the market portfolio. The proportion of each stock in the market portfolio equals the market value of the stock divided by the total market value of all stocks.

• The market portfolio will lie on the efficient frontier but that point will also be the tangency point to the capital allocation line (CAL) which is specific for every investor. Due to this the capital market line (CML) which starts from the risk free rate to the market portfolio would be the most suitable CAL. • The risk premium on the market portfolio will be proportional to its risk and the degree of risk aversion of the representative investor. • The risk premium on individual assets will be proportional to the risk premium on the market portfolio and the beta coefficient (β) of the asset relative to the market portfolio. Beta measures the systematic risk which the investor undertakes when he holds the market portfolio. Beta measures the extent to which the stock and the market move together. It explains the sensitivity of the portfolio to the Page 39 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 movement of the market or the index. During bull markets an investor would hold stocks of high beta and during a bull run a portfolio of low beta would be preferred. The market portfolio will have a beta of 1. Page 40 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 The risk premium on the individual securities isThus from the above two we getWhere, - The risk free rate of interest. - The expected mean return of market portfolio. - Covariance of the return between asset and the market portfolio. - The expected return on the asset. Page 41 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 The expected return-beta relationship can be explained graphically by the securities market line (SML). It’s useful to compare SML with CML as CML graphs risk premiums of efficient portfolios whereas SML graphs individual asset risk premiums. SML provides a benchmark for the evaluation of investment performance. We can use SML to assess the fair expected return on a risky asset. If a stock is perceived to be a good buy it will plot above the SML. Whereas overpriced stocks plot below the SML. The difference between the fair and actually expected rates of return is called the alpha. In an efficient stock market all prices lie on the SML thus in such a case where securities are priced accurately alpha is always zero. Source- www.investopedia.com Page 42 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008

3.3 Efficient Market Hypothesis The movement of stock prices do not reflect any pattern, in other words there movement is random. The efficient market hypothesis evolved in the 1960’s from

the Ph.D. dissertation of Eugen Fama. This theory suggests that the financial markets are efficient and reflect all available information in their stock prices. The new information which becomes available is immediately impounded into the stock price and reflects all information and beliefs of investors in the prices of the securities. The new information is quickly adjusted in the price. Most investors buy and sell securities under the assumption that the market prices of the securities are efficient and reflect all available information. Investors believe the market is efficient thus the price of the security is correct not under or overvalued. This means that if the markets are efficient and the market prices reflect all information than trading of securities would rather be a game of chance than skill. This means that in case of Mutual Funds the managers get no reward to beat the market since the market prices already reflect all information. There are three versions of the efficient market hypothesis: the weak form, the semi strong form and the strong form hypothesis. Each of the three market forms differ in terms of their assumptions, characteristics and nature about the kind of information which is available to them and how it is reflected in the market prices. Weak form hypothesis states that the stock prices already reflect all information which is available which can be derived by examining history of stock prices, trading volume etc. all such information is readily available and everyone has access to it. Thus it states that if such data could give reliable signals about the future performance of the stock prices then by now all investors already would Page 43 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 have an idea to exploit them. In due course of time such signals lose their value as they become known to everyone. Semi strong form hypothesis states that all publicly available information regarding a particular firm must be already reflected in the stock price. This data may include past prices, company’s financial details, management details, trading volume, future prospects etc. similarly if investors have access to such information then it would be already reflected in the stock prices. This form of market makes useless for investors to search for inefficiently priced shares by analysing unpublished information. This form of market also states that

fundamental analysis techniques will not be able to produce excess returns, thus such analysis can only be used for analysis of new information. Strong form hypothesis states that the stock prices reflect all information which is related to the company. This information includes publicly available information as well as information known only to insiders. This form suggests that stock prices quickly adjust itself to information available whether public or private. Therefore no investors have an edge over the other in terms of information as all information is already reflected. However insider trading is banned in India by SEBI thus this form of market is impossible. (Brealey and Myers, 2000) (Bodie et al, 2005) Page 44 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008

Chapter 4 Literary Review

4.1 Performance Measures of Mutual Funds 4.1.1 Sharpe’s Measure Sharpe’s Measure or Sharpe’s Ratio is a measure of the excess return per unit of risk in an investment strategy. It was developed by William Forsyth Sharpe in the year 1966. This ratio is designed to measure the expected return per unit for a zero investment strategy. The difference between the results of the two strategies represents the results. Sharpe ratio is useless in cases where there is only one investment. As Sharpe ratio deals with prediction of future returns therefore ex post Sharpe ratio has to be taken. William Sharpe also referred this as the reward to variability ratio. Page 45 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 Where, - Return on the fund in period t. - Return on the benchmark portfolio in period t. - Average value of over historic period from t=1 to T. - Standard deviation over time period. - Ex-post Sharpe ratio. (Sharpe 1994) This ratio is used to measure or rank the performance of portfolio or Mutual Funds. This is also used to calculate the return which an investor earns in respect to the level of risk he undertakes. Sharpe ratio is used to compare two assets which have the same benchmark, and then in such a case the asset with the highest Sharpe ratio gives more return for the same level of risk. Sharpe

evaluated the performance of 34 open ended Mutual Funds between the period 1954-63 and found out that there was considerable variation in the R/V ratio. This was attributed to the fact that there were a lot of expenditures by many funds also it could be that funds differ in their management styles. These funds were compared with Dow- Jones industrial average. (Sharpe 1966). Page 46 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 4.1.2 Jensen’s Measure Jensen (1968) pointed out two techniques of portfolio evaluation• The ability of the portfolio manager to increase returns on the portfolio through prediction of future security prices. • The ability of the manager to reduce risk which is born by investors. Earlier measures like that of Treynor and Sharpe ranked the portfolios on a risk adjusted basis whereas Jensen constructed a measure of absolute performance on risk and through which performance of different funds could be compared. Comparing different funds enabled the determining of the portfolios manager’s skill whether he is able to earn higher returns through prediction of stock prices or not. Security market line (SML) also explains the concept of Jensen’s alpha, SML in CAPM is used to determine the expected return for a given beta. The exante SML represents different expectations of different investors for different risk bearing investments. Whereas the ex-post Security Market Line represents the behaviour of actual returns. The average return of a fund performing well be higher as compared to the return predicted by the SML similarly it will be much lower then what will be predicted by the SML. Jensen’s alpha measures the performance of a portfolio by this deviation from the SML. Where, - Expected return on portfolio. Page 47 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 - Risk free rate. - Beta of the portfolio. -Market rate of return. - Error term. As per CAPM alpha should be zero because the efficient market hypothesis holds good. Despite the fact that the EMH holds good many managers generate positive alphas. This is because they have some information which is only available to them or maybe they have better skills as compared to other managers. These managers tend to take more risk as compared to other

portfolios. Jensen in his study compared the performance of 115 Mutual Funds 1945 – 1964. He established that the Mutual Funds on an average did not outperform the market they did not predict future stock prices and no individual fund was able to do better than that was expected. These funds were not successful enough to even recover the management expenses, brokerage expenses etc. 4.1.3 Treynor’s Measure Treynor (1965) developed a measure to evaluate the performance of Mutual Funds. He analysed that the major problem in portfolio evaluation was risk measurement. He introduced the concept of characteristic line to define the relationship between portfolio return and benchmark return over a period of time. This line is a simple linear regression of the portfolios returns on the returns of the benchmark. The slope of this line measured the volatility of the funds return in relation to the benchmark return. When the graph was plotted not all points lied on the characteristic line this meant that the risk cannot be entirely Page 48 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 attributed to the market apart from that there are also risks associated to particular securities held in the portfolio. If there are large deviations from the market line then this indicated that diversification was not adequate enough whereas greater the correlation of the portfolio the more diversified the portfolio was. Treynor’s measure was aimed at developing a measure of performance that could be used for all investors. Risk averse investors would prefer lines with larger slopes and vice versa.Ex-post SML was used as a benchmark for performance evaluation of portfolios. Where, - Treynor ratio -Risk free return -Beta of the portfolio. - Portfolio return. Treynor’s measure provides an important guideline for investors and managers. Higher the value of the ratio more is the slope of SML and thus the fund is well suited for all investors irrespective of their risk preferences. The value of the ratio can be negative in spite of the portfolio having a positive beta but a return below the risk less rate would mean a poor fund management. Thus ranking of the portfolios is not affected by changes in risk less return. Treynor’s measure is very similar to Sharpe’s Ratio. However the only difference being that Treynor’s measure relies on beta of the portfolio whereas Sharpe’s

Page 49 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 measure uses standard deviation as the measure of risk. Sharpe’s measure evaluates the performance of the portfolio on the basis of returns as well as the diversification of the portfolio. If the portfolio is fully diversified leaving no scope for unsystematic risk then both the measures will give the same result. However if the manager invests more in high return securities then that fund may have a higher rank as per Treynor’s measure as compared to Sharpe’s measure. Page 50 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 4.1.4 Appraisal Ratio Appraisal ratio or information ratio was first introduced by Treynor and Black (1973). It’s a ratio used to measure the quality of a fund’s investment picking ability. The alpha of the portfolio is divided by the non-systematic risk of the portfolio in other words this measure divides the alpha by its diversifiable risk. This ratio attempts to measure not just the excess return to a benchmark but also how consistent the performance is. This ratio measures the consistency of the manager’s performance against a benchmark. This ratio is a measure of volatility- adjusted return. Where, AR- Appraisal ratio - Jensen’s alpha of the portfolio. - Diversifiable risk. Information Ratio is very similar to Sharpe’s Ratio. However both of these ratios have a fundamental difference. Sharpe ratio compares the excess return of an asset against the risk free asset like that of a T-bill whereas Information Ratio compares active return to the most relevant benchmark. Both these ratios are same only when the benchmark is constant risk free asset like cash. (Pomerantz). The Information ratio is best used as a ranking criterion for Mutual Funds. Information ratio technically is excess returns divided by tracking error. In other words Information ratio is residual return divided by residual risk or alpha divided by residual risk. The higher the ratio the better it is. Page 51 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 (www.financial counsel.com) Page 52 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008

4.2 Past Performances of Mutual Funds

Jensen (1968) in his paper “The Performance of Mutual Funds in the Period 1945-1964” analysed the performance of 115 open end Mutual Funds. Jensen’s alpha was used as the performance measurement tool. It was found out that alpha calculated net of assets was -.011 which meant that the average funds earned about 1.1% lower per year then they should have earned given their level of risk. The distribution was skewed as 76 out of the total funds had less than zero alpha and only 30 had more than 0 alpha. It was further concluded that the Mutual Funds were not being able to predict security prices good enough to outperform the market. Also no individual fund was able to do better than expectation. The funds were not successful and could not even recoup their expenses. McDonald in his paper “Objectives and Performance of Mutual Funds, 19601969” measure and evaluated the risk and return of 123 American Mutual Funds between the periods 1960 to 1969. He based his research on 5 questions. It was found out that in terms of Treynor’s return to beta ratio 67 out of 123 funds exceeded the stock market ratio, similarly more than one half of the funds gave positive Jensen’s Ratio. Sharpe’s measure was less than the markets in case of 84 funds. Whereas nearly half of the funds gave positive alpha’s. In a study by Kim T. in the paper “An Assessment of the Performance of Mutual Fund Management: 1969- 1975”, the author evaluated the quarterly performance of 138 Mutual Funds from the time period 1969 to 1975. The main objective was to evaluate the investment performance of these funds using return performance of three index benchmark portfolios. It was concluded that the 138 Mutual Funds rather performed poorly. Most of the funds specially ones with high risk were the Page 53 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 biggest losers. Thus it was confirmed that the efficient market hypothesis is consistent with the market. Carlson in his paper “Aggregate Performance of Mutual Funds, 1948-1967” analysed the performance of 82 diversified Mutual Funds and compared it with the market index. He used a modified version of Tobin-Sharpe-Linter CAPM and indices were constructed for three types of Mutual Funds, further on each of the index was then compared to the three most popular indices. The major finding of

the study was that the issue of whether the Mutual Fund outperforms the market or not depends upon the time period and the benchmark selected. Past performance of stocks showed no predictable future value. Grinblatt and titman (1989) in their paper “Mutual Fund Performance: An Analysis of Quarterly Portfolio Holdings” analysed the performance of 279 Mutual Funds from the time period 31st December 1974 to 31st December 1984. Grinblatt and titman (1994) in their paper “A Study of Monthly Mutual Fund Returns and Performance Evaluation Techniques” evaluated the performance of 279 Mutual Funds and 109 passive portfolios using different benchmarks. In this paper they contrast the Jensen’s measure, the positive weighting measure developed by them earlier and the timing ability developed by Treynor and Mazuy. Their study revealed that the measures generally give same inferences when using the same benchmark and the results may vary even for the same measure when using different benchmarks. The study revealed that the performance sensitivity depends greatly on the benchmark selection. Secondly it compared the Jensen’s measure with two new measures that were developed to overcome time related problem associated with Jensen’s measure. Lastly it analysed whether fund performance is related to its attributes or not. Page 54 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 Daniel et al (1997) in their paper “Measuring Mutual Fund performance with characteristic-based benchmarks” evaluated the performance of roughly 2500 equity Mutual Funds on a quarterly basis during the time period 31st December 1974 to 31st December 1994. This article introduced a character based benchmark that is designed to measure whether Mutual Funds pick stocks that outperform the market or not. As per the results of the data on an average the Mutual Funds did succeed in picking such stocks. But the difference by which the Mutual Fund beats the market is very small and only covers the expenses. Further on the average fund outperformed the market nine out of ten times between 1975 and 1984 with a yearly average of 2.8% and six out of ten times between 1985 and 1994 with a yearly average of 1.3%. Rao and Ravindran in their paper “Performance Evaluation of Indian Mutual Funds” evaluated the performance of Indian Mutual Funds in a bear market through relative performance index, risk return analysis, Treynor’s ratio, Sharpe

ratio, Jensen’s alpha and Fama’s measure. They considered the closing NAV’s of 268 open ended Mutual Funds which were further reduced to 58 due to returns being less than risk free returns. The time period for the study was September 1998 to April 2002. The main idea behind the research was to find returns which were provided by the individual schemes and their corresponding risk levels as compared to the market and the risk free rate. The main objective was to evaluate the performance of funds during the bear market using different measures. It was concluded that the Treynor ratio for 38 out of 58 funds were positive whereas in the case of Sharpe ratio 30 funds were positive. More than half of the funds had positive Jensen’s measure whereas only 30 provided excess returns over risk free rates this was however due to low CAPM returns. According to RPI analysis, out of the 269 schemes under study 49 were under performers, 102 were par performers and 118 outperformed the market. Medium term debt Page 55 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 funds were considered best investment options as compared to others. The results of the research suggest that most of the Mutual Fund schemes out of the sample of 58 schemes were able to satisfy investor’s expectations by giving excess returns over expected returns based on premium for systematic and total risk. Jayadev(1996) in his paper “Mutual Fund Performance: An Analysis of Monthly Returns” evaluated the performance of two growth oriented Mutual Funds on the basis of their monthly returns and compared it to the benchmark returns. Mastergain and Magnum express were the two funds which were compared to the benchmark return. This paper basically attempted to answer whether growth funds earn higher return than the benchmark return in terms of risk and whether growth funds offer the advantages of diversification market timing and selectivity of securities for their investors. For this purpose the author employed performance measures like Jensen’s alpha, Treynor’s ratio and Sharpe’s ratio, regression, selectivity etc. It was concluded that the two growth funds did not perform better than their benchmark indicators. The two funds were found to be poor in earning better returns and selecting underpriced securities. The funds

failed to perform better than the market portfolio and are not capable of offering the advantages of diversification and professionalism to the investors. Deb et al in their paper” Performance of India Equity Mutual Funds vis-a-vis their Style Benchmarks; An Empirical Exploration” did a return based analysis of equity Mutual Funds in India and compared their relative performance to the benchmarks. The author in this paper did a style analysis using Sharpe’s RBSA approach. The time period taken in consideration was January 2000 to June 2005 and ninety six equity Mutual Funds were considered and compared to their benchmarks. According to the analysis it was concluded that the Indian managers were not able to beat their benchmarks. Page 56 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 Anand et al in their paper “Analysis of Components of Investment PerformanceAn Empirical Study of Mutual Funds in India” analysed the performance of 113 selected schemes for the time period April 1999 to March 2003. The main objectives of the study were to examine the degree of correlation that exists between the fund and market return, to understand the impact of fund characteristics of the performance and to evaluate the diversification and selectivity of fund managers. The BSE index was considered as the benchmark for evaluation. It was concluded that majority of the schemes showed underperformance in comparison to the risk free rate. This implied that the Mutual Funds did not compensate the investors for the additional risk they undertook. The fund managers were not capable of generating excess returns as compared to the expected return. The study concludes that the fund manager’s diversification strategy has not provided any additional return which compensates the investor’s for the diversifiable risk. Thus it can be inferred that the forecasting skill and stock selectivity skills of fund managers was lacking during the sample period. Rao in his paper “Investments Styles and Performance of Equity Mutual Funds in India” analysed the performance of open ended equity Mutual Funds for the period April 2005 to March 2006. It was concluded that only four growth and one dividend plan out of the total 42 plans studied could out beat the market, whereas the rest did not perform well enough. Page 57 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 Page 58 of 91

PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008

Chapter 5

Data Description and Methodology The study takes into account the performance of Mutual Funds as against the stock market index. For this study we take the time period April 2003 to March 2008 and select 20 open ended equity diversified growth Mutual Funds. The data is collected on a monthly basis and is compared to the movement of the BSE 500. The closing NAV’s is collected and similarly the closing BSE 500 index is collected on a monthly basis. Out of the 20 Mutual Funds selected for the research 10 are top performing whereas the other 10 are laggard funds. Thus the sample which we have consists of both top performing and worst performing funds. This gives us uniformity in our data selection and gives us a more representative sample of the market. The funds which are selected are growth funds and dividends are not paid out in these funds, but they are included in the NAV’s of these funds. Compared to dividend funds the returns on these funds are similar. The only difference is that in case of dividend funds the dividend is paid out and has to be added to the NAV as and when declared. Thus these growth funds are already adjusted according to the amount of dividend.

5.1 Sources of Data The data for the study is widely available on the net on the following sites• www.indiainfoline.com • www.amfiindia.com • www.moneycontrol.com • www.utimf.com Page 59 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 • www.tatamutualfund.com • www.sharekhan.com . • www.reliancemutualfund.com • www.franklintempleton.com • www.icicidirect.com The risk free rate which is used for the research is the interbank rate of the Reserve Bank of India (RBI). This rate can be obtained from the website of RBI i.e. www.rbi.org.in.

5.2 Stock Market Index In order to correctly measure the performance of Mutual Funds it’s very essential

to have a benchmark which is best suited. In our case we consider the benchmark as BSE 500. Bombay stock exchange (BSE) is the oldest stock exchange with a rich heritage and was established in 1875 as “The Native Share & Stock Broker’s Association”. It received permanent recognition from the Government of India in 1956 under the Securities Contract Act 1956. In February 1999 BSE constructed a new index called the BSE 500 consisting of 500 scripts and launched it in August 1999. This index broadly represents 93% of the total market capitalization and covers all major 20 sectors of the economy. This index was initially calculated on the basis of “Full Market Capitalization” methodology but was shifted to Free Float methodology from September 2003. All over the world major indices like MSCI, FTSE, S&P, Dow Jones etc are calculated by the same way as BSE 500. BSE is the world’s number one exchange in terms of the number of listed companies and the world’s fifth in terms of transactions. Page 60 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 (www.bseindia.com) Page 61 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008

5.3 Net Asset Value (NAV) Net asset value of a company is the total assets minus the liabilities. It’s the cumulative market value of the assets net of its liabilities the fund holds. This is the value the shareholders or unit holders will get if the fund is liquidated. For e.g.- if a company has assets worth $200 million and liabilities worth $20 million then its net asset value would be $200 million minus $20 million which is $180 million. The NAV of an investment company fluctuates daily as its value of assets and liabilities change daily. The NAV is generally mentioned in terms of per unit which is calculated by dividing the total NAV by the number of units. In our research we consider only the closing NAV of the funds for each month. In case of Mutual Funds NAV’s are most important to investors as it’s from NAV that the price per unit of a fund is calculated. For the purpose of our research we have only considered growth funds. Although in terms of returns they are similar to dividend funds but we have only considered the growth funds. In case of dividend funds the dividend is incorporated in the fund as we take the closing NAV. Both of

these funds appeal differently to different investors. Growth funds provide investors with capital gains whereas dividend funds provide investors with a continuous income.

5.4 Return The NAV taken is the closing NAV of every month for each Mutual Fund. For each Mutual Fund under study the monthly returns are calculated as followsR= ln (closing NAV/ starting NAV) The market returns are calculated on a similar basis. R=ln (closing index/ starting index) Page 62 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008

5.5 Geometric Mean GM or Geometric Mean is a kind of average of a set of numbers of only a positive set of numbers. It summarizes the rate of return over a historical period. This type of mean is used when evaluation of past performance needs to be done and there is a long period of time. This is calculated by multiplying all numbers (call the number of numbers as n) and then taking the nth root of the total. (www.easycalculation.com) Where, Rg- geometric mean R1, r2 ...rt –rate of returns for t time period for n periods.

5.6 Risk 5.6.1 Total Risk Standard deviation is the measure of total risk. It is also known as volatility. Page 63 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 Where, - Standard deviation. - Number of weeks in the time period. - Return on portfolio. - Average monthly return. 5.6.2 Systematic Risk Systematic risk is that risk which remains even after extensive diversification. This risk is attributable to market risk sources which affect all securities. This risk cannot be eliminated. Beta is the measure of systematic risk. This risk is also called non- diversifiable risk. High values of beta indicate high sensitivity of fund returns as compared to market returns. Whereas lower beta values indicate low sensitivity. During a bull phase high beta values are preferred whereas during bear phase low beta values are preferred. But the formulae used is Where - Return on portfolio.

Page 64 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 -Alpha. - Beta. -Market return. - Error term. 5.6.3 Non Systematic Risk This is also known as diversifiable risk and is industry specific. It can be eliminated by diversification. The extent of diversification can be measured by the value of coefficient of determination i.e. r2 . A low value of r2 indicates that the fund can diversify more and still has scope for diversification. The value of r2 is obtained by regression Unsystematic risk= total risk – systematic risk Where, - Total risk. - Beta square. - Market risk. Page 65 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 Source- Ross et al 2006.

5.7 Sharpe Ratio Sharpe ratio or reward to variability ratio developed by William Forsyth Sharpe is the measure of excess return to volatility or excess return to the risk free assets as compared to the total portfolio. Sharpe assumed that the investor only holds one portfolio and does not diversify his risk thus he must get a premium for this. Sharpe’s ratio is considered better as compared to Treynor’s measure as it considers whether investors are rewarded reasonably well for the risk they take as compared to the market or not. A fund having a high unique risk may outperform the benchmark in Treynor’s measure but underperform in Sharpe’s ratio. However Sharpe’s ratio is based on capital market line, which only takes in to account efficient portfolios and ignores inefficient portfolios; hence for this purpose we only take efficient portfolios. For our research purpose the Sharpe ratio for the benchmark and the market is calculated and compared whether the funds outperform the benchmark or not. Page 66 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008

5.8 Treynor’s Measure Treynor ratio compares the return earned in excess of what could have been earned on a risk free investment. It measures the excess return to the systematic risk in other words reward to variability ratio or Treynor’s measure indicates the risk premium per unit of systematic risk. Beta for the market is always 1, thus Tp for the market is Rm – Rf . If the Tp of the portfolio is greater than that of the market then the scheme has outperformed the market. However this measure can only be applied to positive beta’s only during the

bull phase of the market. If applied during the bear phase then the results can be misled as the schemes will have negative betas. Other than this Treynor’s measure ignores the reward for non-systematic risk.

5.9 Jensen’s Measure This is also known as Jensen’s alpha and is used to determine the excess return of a security over other securities expected return. It measures the absolute performance of the portfolio and considers only the systematic risk. This was developed by Michael Jensen in 1970’s and the main feature of this model is that it helps to assess the ability of the fund manager. A positive Jensen’s alpha would indicate that the fund has a higher return over the CAPM and lies above the security market line whereas a negative would represent the opposite. Page 67 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008

5.10 Appraisal Ratio This ratio is also known as Information Ratio. It is used to measure the abnormal returns per unit of risk that could be diversified by the portfolio. It analyses the performance of Mutual Funds and is obtained by dividing the active return by the tracking error.

5.11 Linear Regression The linear regression is run for Rp-Rf vs. Rm-Rf and the value of R2 is calculated.R2 is the coefficient obtained by running regression which determines the extent to which a portfolio is diversified and whether further diversification is possible or not. A low R2 means that there is scope for diversification whereas a high R2 would mean that the fund is properly diversified. R2 also determines the correlation between the fund and the market returns. Page 68 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008

Chapter 6 Analysis and Interpretation of Data The study focused on the performances of 20 open ended equity diversified growth Mutual Funds and compared their monthly NAV’s to the market index. The study was conducted from April 2003 to March 2008. The following are the results of the research. Sl.No . Fund Name 1 Franklin India Blue Chip (G) 2 HSBC Equity Fund G 3 Tata Growth Fund 4 Reliance Vision Fund Growth 5 Reliance Growth Fund 6 Birla Sun Life Advantage Mutual Fund 7 Birla Sun Life Mid Cap (G) 8 DBS Chola Fund (G) 9 JM Equity Fund

10 DSP ML Top 100 Equity Fund Page 69 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 11 Franklin India Prima Plus 12 HDFC Growth Fund 13 HDFC Top 200 Fund 14 ICICI Prudential Power Fund (G) 15 ICICI Prudential FMCG Fund (G) 16 Kotak Tech Fund (G) 17 Sahara Growth Fund 18 Tata Pure Equity Mutual Fund 19 Sundaram BNP Paribas Select Midcap Fund 20 Tata Equity Opportunities Fund Page 70 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 Sl.No . Fund Name Alpha Beta R2 1 Franklin India Blue Chip (G) .005217 .88 .944 2 HSBC Equity Fund G .00954 .899 .906 3 Tata Growth Fund .00279 .91 .804 4 Reliance Vision Fund Growth .00647 .93 .913 5 Reliance Growth Fund .012954 .95 .862 6 Birla Sun Life Advantage Mutual Fund .000983 .94 .933 7 Birla Sun Life Mid Cap (G) .0093356 .853 .817 8 DBS Chola Fund (G) -.01813 .950 .397 9 JM Equity Fund .001264 .915 .891 10 DSP ML Top 100 Equity Fund .00662376 .906 .946 11 Franklin India Prima Plus .0078741 .828 .920 12 HDFC Growth Fund .0074972 .891 .932 13 HDFC Top 200 Fund .0068749 .886 .960 Page 71 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 14 ICICI Prudential Power Fund (G) .00493 .920 .928 15 ICICI Prudential FMCG Fund (G) .009265 .698 .627 16 Kotak Tech Fund (G) -.00501 .643 .449 17 Sahara Growth Fund .0047796 .873 .914 18 Tata Pure Equity Mutual Fund .0080492 .922 .926 19 Sundaram BNP Paribas Select Midcap Fund -.0288497 1.057 .385 20 Tata Equity Opportunities Fund -.0150417 6 1.054 .583 Average .0018707 .89525 .8018 Minimum -.028849 .643 .385 Maximum .012954 1.057 .960 Page 72 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 Page 73 of 91

PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 Sl.No . Fund Name Sharpe Ratio Treynor Ratio Informati on Ratio 1 Franklin India Blue Chip (G) .341 .027 18.946 2 HSBC Equity Fund G .393 .031 19.359 3 Tata Growth Fund .282 .024 2.2992 4 Reliance Vision Fund Growth .348 .028 13.0396 5 Reliance Growth Fund .420 .034 15.16119 6 Birla Sun Life Advantage Mutual Fund .278 .022 2.59562 7 Birla Sun Life Mid Cap (G) .377 .0320 9.6647 8 DBS Chola Fund (G) .01694 .00206 -2.23983 9 JM Equity Fund .276 .022 2.085447 10 DSP ML Top 100 Equity Fund .359 .028 23.78306 11 Franklin India Prima Plus .382 .030 22.33381 12 HDFC Growth Fund .371 .029 21.98926 13 HDFC Top 200 Fund .334 .026 35.57288 14 ICICI Prudential Power Fund (G) .332 .02652 12.79633 15 ICICI Prudential FMCG Fund (G) .354 .03442 5.40843 16 Kotak Tech Fund (GPa)ge 74 of 91.116 .01335 -1.66755 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 Average .285185 .02321 11.3271 Minimum -.049 -.006 -2.73471 Maximum .420 .03442 35.57288 Page 75 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008

6.1 Beta Beta measures the level of systematic risk in the portfolio. In our research we compare the beta of the portfolio to the market index i.e. BSE 500. The beta of the market portfolio is assumed to be 1. The beta in our research ranges from .643 to 1.057 which is shown above. However only two Mutual Funds have beta greater than the market beta which shows that these funds bear more risk as compared to the market. The average beta of the funds is .89525 which is close but less than one. Thus it can be stated that the funds are less risky than the market and the fund manager would hold these portfolios and beat the market.

6.2 Sharpe Ratio Sharpe ratio is calculated to compare between funds as which funds perform better compared to others in terms of total risk. The ratios for different funds are given above. The Sharpe ratio of the funds in this research ranges between -.049 and .420. This means that out of the 20 funds undertaken for

research only one fund had a negative Sharpe ratio, in other words this fund has performed the worst and is not capable of giving better returns as compared to the risk free rate. Whereas the fund with the highest Sharpe ratio gives the maximum return and has outperformed the other funds. The Sharpe ratio for the market index is .2751420 which is less than the average of all the funds which is .285185. Other than this 16 funds have a Sharpe ratio greater than that of the market whereas only 4 funds have a Sharpe ratio less than the markets. Thus it can be concluded from the above that the Mutual Funds in India have the capability to outperform the market and get better returns as compared to the market. Page 76 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008

6.3 Treynor Ratio Treynor ratio measures the funds risk adjusted return per unit of market risk. A higher Treynor ratio would indicate better risk adjusted performance. The Treynor ratio for the research is given above. The range of the ratio of the funds is from -.0064 to .03442. This means that only one fund has a negative Treynor ratio whereas 19 of the total 20 funds have positive Treynor ratio. This means that all these funds having positive Treynor ratio are capable of earning a higher return than the risk free rate. The average of the Treynor ratio for the funds is .02321 which is higher in comparison to the market index ratio which is .0201. This clearly states that the Mutual Funds have outperformed the market portfolio. Apart from this 16 of the total 20 funds under this research have a greater Treynor ration as compared to the market ratio and only 4 Mutual Funds have a Treynor ratio which is less than the market ratio. Thus it’s clear that the Mutual Funds have outperformed the market index.

6.4 R

2

If R2 is above 70% then the model is supposed to be fit. R2 is the percentage of variation in the dependent variable explained by the independent variable. R2 in our sample ranges from .385 to .960 with an overall average of .8018. This means that 80.18% of funds observations are explained by the market premium. In our observations 15 out of 20 funds have a R2 above 70%. If R2 is less than 70% than further diversification is possible and the fund manager should diversify the fund more as that would get him better returns for the fund.

6.5 Jensen’s Alpha

Page 77 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 Jensen’s alpha is used to measure the abnormal performance of Mutual Funds. Jensen’s alpha indicates security selectivity and the judgement of the fund manager. This implies that with a random selection buy and hold policy the performance should give an alpha of 0. The values of alpha’s in our research range from -.0288497 to .012954 and the average being .0018707. This

indicates that all the funds on an average earned .18% per year more than the expectation with a given level of systematic risk. Out of the 20 funds under the research only 4 had negative alphas whereas all other 16 funds had positive alphas. This shows that a majority of the fund managers are able to generate positive abnormal returns and profits for their respective funds.

6.6 Information Ratio The information ratio ranges from -2.72471 to 35.5728 where the average is 11.3271. There are only 4 funds with negative information ratio which is only due to negative alphas. As the unsystematic risk for many funds is low thus alpha when divided by this risk would give higher values. Funds which have lower Information Ratios is due to lower values of alpha. The higher the ratio the better it is.

6.7 Limitations of the Study

• The data collected is through online sites which in turn are supplied by members. There is no uniform rule in the data collection and its computation. Page 78 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 • This study excludes the effect of entry and exit loads of the Mutual Funds. The transaction costs and other expenses like research expenses, management expenses etc are not taken into account. This could reduce the rate of return of the fund which is earned by the investor. All the data used is gross of expenses and the return calculated is higher than the actual, thus there is a difference. • Survivorship bias- survivorship bias affects almost every Mutual Fund performance and mostly all datasets include only those funds which are currently in operation and available for investment. Survivorship bias leads to an overestimation of performance of a fund’s portfolio. In Mutual Fund industry survivorship bias is referred to as ‘Fund Disappearance’ or ‘Fund Attrition’. Funds that disappear tend to do so because of poor performance, these funds are not dissolved but are usually merged with some other fund. These unhealthy funds still have the capability to earn fees to the organization this they are merged not dissolved also this step maintains the institutions image as the funds are not listed and not published. Most of the past studies did not take in to account the issue of survivorship bias. Those studies only focused on the funds which continuously existed over a period of time for which the performance was evaluated. The other funds simply were not taken as a part of the research. Studies by Sharpe, Jensen, and Treynor all did not consider the issue of survivorship bias. However the issue of survivorship bias persists due to the availability of data. The data which is available is only there for funds which are in existence and currently traded. As for my research the data collected was from April 2003 to March 2008 and Page 79 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 the data was collected online, thus this data only represents funds which were actively traded during that time period. (Elton et al, 1996).

• Window dressing- at the time of declaration of results the fund managers change the composition of their funds and portfolio’s to make it look more attractive. • Tax reliefs- returns from Mutual Funds may be in the form of capital gains or dividends. The tax implications in India are different for different types of returns. As every investor has different needs thus the tax treatment also depends upon the type of benefits derived from these funds. This research does not take into account such advantages. • Expense ratio- expense ratio states how much one pays a fund in percentage term annually to manage the money. The fund’s NAV’s are reported net of fees and expenses. Thus it’s very important to know how much the fund is deducting. A major part of the expense ratio is the management and advisory fees. The AMC generates profits from the management fees. A good performing fund may charge a high management fees, thus it’s very important to choose the right fund which maintains a balance. • The Mutual Funds undertaken for the research are growth funds which have dividend reinvested in them. However the benchmark index i.e. BSE 500 does not account for the dividend factor. This is due to the fact that the average dividend yield for the market is not available. Thus the market index does not include the dividend factor. Page 80 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008

Franklin India Blue Chip (G)

Month NAV Return Rf rate BSE 500 Return Rp-Rf Rm-Rf March 03 22.42 1071.45 April 03 22.86 0.019435241 6% 1068.03 -0.003197041 0.014447699 -0.008184583 May 03 25.63 0.114374882 6% 1235.76 0.145870335 0.10938734 0.140882794 June 03 28.44 0.104033065 6% 1373.56 0.105719744 0.099045523 0.100732203 July 03 30.73 0.077442771 6% 1439.3 0.046750975 0.07245523 0.041763433 August 03 35 0.130108685 6% 1687.35 0.159002367 0.125121144 0.154014825 September 03 36.59 0.044426918 6% 1748.43 0.035558991 0.039439376 0.03057145 October 03 41.12 0.116719642 6% 1877.14 0.0710311 0.111732101 0.066043558 November 03 43.35 0.052812082 6% 1991.74 0.059259287 0.047824541 0.054271745 December 03 51.42 0.170720499 6% 2366.36 0.172344281 0.165732957 0.167356739 January 04 51.62 0.003881992 6% 2246.83 -0.051832576 -0.001105549 -0.056820117 February 04 52.57 0.018236421 6% 2228.41 -0.008232007 0.013248879 -0.013219549 March 04 52.52 -0.000951565 6% 2243.6 0.006793392 -0.005939107 0.00180585 April 04 54 0.027789997 6% 2321.25 0.034024115 0.022802456 0.029036574 May 04 45.25 -0.176781376 6% 1891.75 -0.204603507 -0.181768918 -0.209591049 June 04 47.04 0.038795633 6% 1923.78 0.016789674 0.033808092 0.011802132 July 04 49.64 0.053798657 6% 2081.26 0.078681479 0.048811115 0.073693937 August 04 50.54 0.017968142 6% 2125.65 0.021104158 0.0129806 0.016116617

September 04 53.56 0.058037419 6% 2276.87 0.068724055 0.053049877 0.063736513 October 04 53.16 -0.007496287 6% 2319.3 0.018463723 -0.012483828 0.013476182 November 04 59.39 0.110819628 6% 2548.36 0.094184599 0.105832087 0.089197057 December 04 64.07 0.075850374 6% 2779.65 0.086875005 0.070862832 0.081887464 January 05 63.12 -0.014938559 6% 2726.49 -0.019309953 -0.019926101 -0.024297494 February 05 65.67 0.039604524 6% 2825.65 0.035723359 0.034616982 0.030735817 March 05 62.78 -0.045005649 6% 2734.66 -0.032731313 -0.04999319 -0.037718854 April 05 59.61 -0.051813206 6% 2610.5 -0.04646534 -0.056800748 -0.051452881 May 05 64.30 0.075736286 6% 2829.2 0.080452212 0.070748745 0.075464671 June 05 67.20 0.044113616 6% 2928.31 0.034431479 0.039126075 0.029443937 July 05 73.08 0.083881484 6% 3124.78 0.064938416 0.078893942 0.059950874 August 05 76.89 0.050821098 6% 3273 0.046343115 0.045833556 0.041355573 September 05 82.85 0.074655915 6% 3521.83 0.073273745 0.069668373 0.068286204 October 05 75.99 -0.086429991 6% 3198.69 -0.09623939 -0.091417533 -0.101226931 November 05 85.74 0.120717708 6% 3568.37 0.109367558 0.115730167 0.104380016 December 05 90.48 0.053809371 6% 3795.96 0.061828434 0.048821829 0.056840893 January 06 96.67 0.066174285 6% 4004.96 0.05359625 0.061186743 0.048608708 February 06 101.88 0.052492534 6% 4130.07 0.030760763 0.047504992 0.025773222 March 06 111.88 0.093631218 6% 4516.73 0.089493925 0.088643677 0.084506383 April 06 117.36 0.047819266 6% 4829.73 0.067002285 0.042831724 0.062014743 May 06 101.99 -0.140371365 6% 4157.93 -0.149773211 -0.145358906 -0.154760753 June 06 100.38 -0.015911785 6% 4029.97 -0.031258423 -0.020899327 -0.036245964

Page 81 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 July 06 101.54 0.011489825 6% 4029.43 -0.000134005 0.006502284 -0.005121547 August 06 110.83 0.087544686 6% 4423.88 0.093392212 0.082557145 0.088404671 September 06 117.41 0.057674587 6% 4739.67 0.068950374 0.052687045 0.063962832 October 06 124.02 0.05477076 6% 4957.37 0.044907845 0.049783219 0.039920304 November 06 128.99 0.039292039 6% 5227.73 0.053101791 0.034304498 0.04811425 December 06 131.67 0.02056391 6% 5270.76 0.008197415 0.015576369 0.003209874 January 07 134.23 0.019255954 6% 5408.71 0.025836052 0.014268413 0.020848511 February 07 122.35 -0.092668957 6% 4938.08 -0.091034025 -0.097656498 -0.096021567 March 07 120.86 -0.012252939 6% 4955.39 0.003499281 -0.01724048 -0.00148826

April 07 131.46 0.084069772 6% 5311.03 0.069309917 0.07908223 0.064322376 May 07 139.78 0.061367135 6% 5646.9 0.061320932 0.056379594 0.05633339 June 07 142.43 0.018780893 6% 5781.37 0.023533957 0.013793351 0.018546415 July 07 151.08 0.058958847 6% 6063.2 0.047597035 0.053971305 0.042609493 August 07 148.18 -0.019381747 6% 5950.11 -0.018828007 -0.024369288 -0.023815548 September 07 165.00 0.107517723 6% 6773.54 0.129614139 0.102530181 0.124626597 October 07 184.31 0.110673649 6% 7785.22 0.139203219 0.105686107 0.134215677 November 07 183.88 -0.002335752 6% 7865.98 0.010320067 -0.007323293 0.005332526 December 07 194.09 0.054038598 6% 8592.43 0.088334452 0.049051057 0.08334691 January 08 166.64 -0.152486172 6% 7160.03 -0.182367412 -0.157473714 -0.187354954 February 08 163.59 -0.018472499 6% 7108.12 -0.007276378 -0.023460041 -0.01226392 March 08 147.11 -0.106182691 6% 6157.27 -0.143604295 -0.111170233 -0.148591837

Page 82 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 The results of the above fund are as followsStandard deviation of Fund-.069940351 Geo Mean Fund-.028898861 Geo Mean Index- .026144797 Co Variance-.005137466 Variance Index-.005912955 Beta-.883575486 Non Systematic Risk-.000275375 Standard Deviation Index-.076895741 Sharpe Ratio-.341881605 Geo Mean Risk Free Asset-.004987542 Treynor Ratio-.02706200 Jensen’s alpha-.005217288 Variance Fund-.004891653 R2-.944 Ep-.01674 Information Ratio-18.94608845 Page 83 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 In the above example the comparison between Franklin India Blue Chip (G) and the BSE500 has been shown. The closing NAV’s of the fund is compared with the market index return for the time period April 2003 to March 2008. The data for the fund was collected from www.indiainfoline.com and the market index was collected from www.bseindia.com . The risk free rate used is the interbank rate of the RBI. Performance measures like Sharpe ratio, Jensen’s alpha, Treynor ratios etc are calculated using excel and SPSS. All other funds were worked upon in the same way as above. The results of the other funds have been included in the table given above.

Page 84 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008

Chapter 7

Conclusion The Indian Mutual Fund industry has grown and is growing at a tremendous pace. All this is due to the fact that the whole Indian economy is booming in all sectors. This study was conducted to understand the Mutual Fund industry, similar studies have been conducted in the past but none such study has been conducted as this study is relatively new. This study measured the performances of various funds through their NAV’s and compared it to the market sensex. The performance comparison was made through various risk adjusted performance measures like Sharpe ratio, Treynor ratio and Jensen’s alpha. All these measures are the results of previous studies by these scholars. This study not only focused on the comparison of the Mutual Fund performance with the market but it also explained other aspects relating to the Mutual Funds. The performance of Mutual Funds and the market have attracted a lot of attention and has been a topic of research all along. Researchers like Sharpe (1966) and Jensen (1968) conducted similar researches and concluded that the market is efficient and the Mutual Funds cannot outperform the market nor can the market outperform the Mutual Funds. This research focused on the performance of 20 open ended equity diversified Mutual Funds from the period April 2003 to March 2008 and compared the monthly NAV’s with the benchmark index i.e. BSE 500. The result of this research is inconsistent with the efficient market hypothesis which states that the Mutual Funds do not outperform the market and there is no reward for managers in seeking to beat Page 85 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 the market. Efficient market hypothesis indicate that all information is reflected in the prices of the securities and no one can achieve higher returns than the market. Thus we can say that in Indian stock market the efficient market hypothesis does not hold good and the markets are not efficient. The fund managers have better skills and can generate higher returns for their funds. These managers have access to information which otherwise is not readily available. Institutional investors and fund managers take advantage of this inefficiency and generate higher returns for their funds and generate abnormal profits for the investor. The research conducted has given results which are contrary to previous studies. According to Anand et al the Mutual Funds underperformed the market and the managers were not skilled enough to provide for better returns than the expected returns. In our study the Mutual Funds have outperformed the market and the managers are skilled enough to diversify the fund portfolio and beat the market. Similarly the results of the studies conducted by Deb et al, Rao and Jayadev are all contrary to this research. As all the above mentioned studies concluded that the Indian Mutual Funds did not beat the market, the fund managers were not skilled enough and the investors did not gain the advantage of diversification and professionalism which these funds offer. Comparing this to my research majority of the funds

have outperformed the market index and have low levels of risk and high returns as compared to the BSE 500. Only the research conducted by Rao and Ravindran gives similar results as this research. Both of these researches provide that the Mutual Funds are able to satisfy investor’s expectations by giving excess returns over expected returns. Page 86 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008

7.1 Recommendations for Future Research For further research one can employ various other models on the same data set that would provide us with better results and an in depth analysis. Due to time constraints my research just focused on the funds which copy BSE Sensex and benchmark their portfolio to the Sensex’s portfolio. However for a more detailed analysis of the Indian Mutual Fund market one could focus on other index’s like Nifty, Crisil etc. Portfolio risk through measure of Value at Risk (VAR) can also be tested for differences in Mutual Fund classes Page 87 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008

References • Anand S. and Murugaiah V.,”Analysis of Components of Investment Performance- An Empirical Study of Mutual Funds in India”. • Bodie, Kane and Marcus (2005), Investments, 6th (ed.), New York: McGraw Hill Higher Education. • Brealey R. And Myers S. (2000). “The Principles of Corporate Finance”, McGraw Hill, London. • Carlson S.R., “Aggregate Performance of Mutual Funds, 1948-1967”. • Cavanagh J., Family Economics Mutual Funds, University of Missouri Columbia. • Daniel K., Grinblatt M., Titman S. and Wermers R. (July 1997), “Measuring Mutual Fund Performance with Characteristic-Based Benchmarks”, Journal of Finance, Vol. 52, No. 3. • Deb G. S., Banerjee A. and Chakrabarti B.B., “Performance of Indian Equity Mutual Funds Vis-a-Vis Their Style Benchmarks: An Empirical Exploration”. • Elton, Edwin, Gruber M. and Blake C. (1996), “Survivorship Bias and Mutual Fund Performance”, Review of Financial Studies, Vol.9, No.4, Pg 1097-1120. • Grinblatt M. and Titman S. (1989), “Mutual Fund Performance: An Analysis of Quarterly Portfolio Holdings “, Journal of Business, Vol. 62, Pg 393-416. Page 88 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 • Grinblatt M. and Titman S. (1994), “A Study of Monthly Mutual Fund Returns and Performance Evaluation Techniques”, Journal of Financial and Quantitative Analysis, Vol. 29, Issue 3, Pg 419-444. • Jensen M. (1968), “The Performance of Mutual Funds in the Period 1945-1964”, Journal of Finance, Vol. 23, Pg 389-416. • Jayadev M. (March 1996), “Mutual Fund Performance: An Analysis of Monthly Returns”, Vol. 10, No. 1, Pg 73-84. • Kim T. (1978),”An Assessment of the Mutual Fund Management:

1969-1975”, Journal of Financial and Quantitative Analysis, Vol. 13, No. 3, Pg 385-406. • Kaushal Shah and Associates, “The Fall and Rise of Mutual Funds in India”. • McDonald J.G. (1974), “Objectives and Performance of Mutual Funds, 1960-1969”, Journal of Financial and Quantitative Analysis, Pg 311-333. • Pomerantz S., “Information Ratio- What is it and Why is it Important?” Securities Insight for Attorneys. • Ross, Westerfield and Jordan (2006), “Fundamentals of Corporate Finance” 7th edition, McGraw Hill. • Rao N.D., “Investment Styles and Performance of Equity Mutual Funds in India”. • Rao N.S. and Ravindran M., “Performance Evaluation of Indian Mutual Funds”. • Sharpe W. (1994),” The Sharpe Ratio”, Journal of Portfolio Management, Vol. 21, No.1, Pg 49. Page 89 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 • Sharpe W. (1966), “Mutual Fund Performance”, Journal of Business, Vol. 39, Pg 119-138. • Tripathy Prava N. (March 1996), Mutual Fund in India: A Financial Service in Capital Market, Finance India, Vol. 10, No 1, Pg 85-91. • Treynor J.L. and Black F. (1973), “How to use security analysis to improve portfolio selection”, Journal of Business, Vol. 46, No. 1, Pg 66-86. Page 90 of 91 PERFORMANCE OF MUTUAL FUNDS IN INDIA 2003 - 2008 Websites• www.amfiindia.com • www.appuonline.com • www.mutualfundsindia.com • www.investopedia.com • www.bseindia.com • www.indiainfoline.com • www.easycalculation.com • www.moneycontrol.com • www.utimf.com • www.sharekhan.com • www.tatamutualfund.com • www.relaincemutualfund.com • www.franklintempleton.cpm • www.icicidirect.com • www.kotakmutual.com • www.rbi.org.in • www.sec.gov • www.financialcounsel.com

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portfolio A group of investments. The more diversified the investments in a portfolio, the more likely the investor is to earn the same return as the market

DEFINITION: The process of managing the assets of a mutual fund, including choosing and monitoring appropriate investments and allocating funds accordingly a mutual fund The definition of a mutual fund is a form of collective investment that pools money from many investors and invests their money in stocks, bonds, shortterm money market instruments, and/or other securities. In a mutual fund, the fund manager trades the fund's underlying securities, realizing capital gains or losses, and collects the dividend or interest income. The investment proceeds are then passed along to the individual investors. The value of a share of the mutual fund, known as the net asset value per share (NAV), is calculated daily based on the total value of the fund divided by the number of shares currently issued and outstanding.

Regulated by the Investment Company Act of 1940, mutual funds are open-ended investment companies that pool investors' money into a fund operated by a portfolio manager. This manager then turns around and invests this large pool of shareholder money in a portfolio of various assets, or combinations of assets. This may include investments in stocks, bonds, options, futures, currencies, treasuries and money market securities. Depending on the stated objective of the fund, each will vary in regard to content and risk.

Mutual Fund Definition An investment mediator that accumulates the money of a group of investors for the purpose of a more efficient achievement of a

predetermined investment objective is called a mutual fund. The management of the pooled resources is called a fund manager, who is responsible for the buying of particular securities such as stocks and bonds. The investment in a mutual fund turns you into a fund shareholder.