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Review of literature


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Review of literature

  1. 1. REVIEW OF LITERATUREFriend et al., (1962) had done an extensive and systematic study of mutual funds. The studyconsidered 152 mutual funds with annual data from 1953-1958. Using their own benchmark, theauthor found that mutual funds earned an (unweighted) average annual return of 12.4 percentwhile their composite benchmark earned a return of 12.6 percent. Their alpha –of –sorts was anegative 20 basis points .on the whole, it was revealed that overall results did not suggestwidespread in efficiency in the industry. The study also compared returns of the funds acrossturnover categories and expenses categories. The analysis did not reveal a strong relationshipbetween turnover rates and performance. The same was found to be true in respect of expenses.The Wharton study on the performance of mutual funds was followed by trey nor, (1965) whenhe devised a satisfactory way to measure the performance of a fund with the help of thecharacteristics line and the portfolio possibility line .The characteristics line contains informationabout expected rate of return and risk. The slope of the line measures volatility .the purpose ofthe portfolio possibility line is to relate the expected return of a portfolio containing the fund tothe portfolio owner’s risk preferences. He found that relative quantitative performance rankingscould be read directly from the characteristic line despite market fluctuations and different riskpolicies.Another study was conducted by Sharpe (1966) to develop a composite measure that considersreturn and risk. He evaluated the performance of 34 open ended mutual funds during the period1954-63 by the measure so developed. He found that the performance of 11 funds were superiorto that of Dow Jones industrial Average’s (DJIA).His reward to variability ratio for each fundwas significantly less than the same measure applied to the DJIA over the study period .Based onthis evidence Sharpe concluded that on an average mutual fund performance was distinctlyinferior to an investment in the DJIA.An analysis of relationship between fund performanceand its expenses ratio indicated that good performances was associated with low expensesratio. On the other hand ,omnly a low relationship was discovered between size andperformance .Notably, there was some consistency in the risk measure over time for alternative
  2. 2. funds.His study concludes that out of 34 funds selected 19 had out performed the benchmark interm of total risk.Levy (1968)4 pondered upon importance to develop an accurate and complete measure ofinvestment performance. In an attempt to develop theoretically sound measures of risk andreturn in portfolio evaluation , he focused on Sharpe measure and put forward somemodification in the Sharpe methodology for calculation of risk and return .The advocated theuse of geometric mean against simple arithmetic mean of sub-period return and vulnerabilityfor variability as used by Sharpe (1966).Jenson (1968)5 analysed the performance on two dimension s. First on the ability of theportfolio manager or security analyst to increase returns on the portfolio through successfulprediction of future security price .Secondly on the ability of the portfolio manager to minimize(through efficient diversification ) the amount of insurable risk borne by the holder s of the portfolio. The author analyzed only the predictive ability of the managers to earn excess return overthe expected return. The analysis was done on 115 open – ended mutual funds in the period1945-1964. It is only an absolute measure. The evidence indicated that these 115 mutual fundsmanagers were on average not able to predict security prices well enough to outperform a buy –the- market-and –hold policy. The study was limited to open –ended schemes.In a further attempt by Smith and Tito (1969)6 a comparison of the composite performancemeasure of Sharpe ,Jensen & Treynor was made and a modified Jensen measure was devised.They applied all the measures in ranking the 38 mutual funds, by taking the 40 quarter periodfrom 1959 to 1967. They have found out that Treynor’s volatility measures provide a much morefavourable view of fund performance than does the Sharpe’s Variability Index. They were of theview that even the unsystematic risk was the important factor in determining whether the fundsoutperform market portfolios. They recommended for the modified Jensen measure because itwas based on estimating equation .finally much attention has been given to the problem ofwhether or not portfolio managers have performed well enough to justify their managementfees.
  3. 3. Friend and Blume (1970)7 commented on the one parameter risk adjusted measures of portfolioperformance of Sharpe ,Trey nor and Jensen as biased and suggested that improved measuresof portfolio performances for any period could be obtained by adjusting the earlier measuresdepending on the degree of risk , they were of the opinion that traditional two parametermeasures would be more useful.Carlson (1970)8 examined the overall performance of mutual funds for the period 1948-1967with emphasis on analyzing the effect of market series used over different time periods. Theanalysis of performance relative to the market indicated that result s were heavily dependent onthe market series used , namely ,S&P500, NYSE composite, or DJIA.For the total periodalmost all fund group out performed DJIA but only a few had gross returns that were betterthan those for S&P 500 or NYSE composite ,although there was consistency in the risk adjustedperformances measures . Carlson also analyzed performances relative to size or expense-ratio,and a new –fund factor. The results indicated no relationship with size or expenses ratio,although there was a relationship between performance and a measure of new cash into funds.Arditti (1971)9 attempted to add an important dimension to the Sharpe (1966) study and showedthat when the third moment of fund annual rate of return was introduced, Sharpe’s conclusiongot altered. As a measure of direction and size of distribution tail, the third moment providedsignificant information .Thus, contraty to Sharpe’s observation; it was found that average fundperformance could no longer be judged inferior to the performance of DJIA. Yet importantfallout was that either fund managers were willing to forgo return at a given level of risk or weretempted to opt more variability in exchange for larger annual returns.Klemosky (1973)10 analysed investment performance of mutual fund based on quarterly returnsfor 40 funds during the period 1966-1971. The analysis identifies bias in Sharpe, Trey nor andJensen measures, which could be removed by using mean absolute deviation and semi –standarddeviation as risk surrogates. The resultant performance measure was claimed to be a better riskadjusted performance measures than composite measures derived from the capital asset pricingmodels.Mc Donald (“1974) 11 examined performance of 123 mutual funds relating it to the statedobjective of each fund. The results indicated a positive relationship between objectives and risk
  4. 4. measures that is risk increasing with the objective becoming more aggressive. Rate of returngenerally increased with aggressiveness and as expected, there was a positive relationshipbetween return and risk. The relationship between objectives and risk-adjusted performanceindicated that more aggressive funds experienced better results, although only one-third of thefund did better than aggregate market.Gupta (1974)12 evaluated the performances of mutual fund industry by differentiating severalsubgroups by their broad investments goals and objectives for the period 1962-71.theperformances model s devised by Sharpe ,Trey nor and Jensen were used .The study evaluatedresults by using both DJIA and S&P500 as market indices .The results obtained indicated thatthese performance model led to identical results .Also that almost all mutual fund subgroupoutperformed the market using DJIA, except and income and balanced group s which based onS&P 500. It also shows that returns per unit of risk varies with the level of volatility assumedand that funds having higher volatility exhibited superior performance than the others . It hasalso shown that all fund types outperformed the market irrespective of choice of market indexand performance measure.