Equity mutual fund performance evaluation : an emerging market perspective

Abstract

The remarkable growth in mutual funds worldwide has enticed academic researchers to evaluate the dynamics of their returns in an attempt to identify skillful managers who can actually create added value for their investors. Nevertheless, the majority of the research papers on this area has focused on mutual funds in developed markets, and thereby leaves the emerging market (“EM”) fund industry relatively underfollowed in this respect. Today, more than ever, this is of potential concern knowing that fund managers are frequently including into their portfolios securities from the less developed economies, whilst a large number of investors believe that EMs are a good entry point for long-term investment due to their growth potential. The uncertainty as to whether investments in riskier and less efficient markets allow managers to “beat the market” remains a question to which answers are required. This empirical work seeks to offer new insights on portfolios of U.S., European and EM domiciled equity mutual funds whose objectives are the investment in emerging economies, and specifically analyses two main issues: alpha generation and the influence of the funds’ characteristics on their risk-adjusted performance. The study uses regression analysis and employs the Jensen’s (1968) Single-Factor model along with the Fama and French’s (1993) and Carhart’s (1997) multifactor models to authenticate results and answer both research questions. The research findings reveal that EM exposed fund managers fail to collectively outperform the market. It thereby offers ground to believe that the emerging world is very close to being efficient, proving that the Efficient Market Hypothesis (“EMH”) ideal exists in this scenario where market inefficiency might only be a perception of market participants as any apparent opportunity to achieve above-average returns is speedily snapped up by very active managers. Overall these managers take a conservative approach to portfolio construction, whereby they are more unperturbed investing in large cap equity funds so as to lessen somewhat the exposure towards risks associated with liquidity, stability and volatility. In addition, the findings show that large-sized equity portfolios have the lead over the medium and small-sized competitors, whilst the high cost and mature collective investment vehicles enjoy an alpha which although is negative is superior to their peers. The riskiest funds generated the lowest alpha, and thereby produced doubts as to whether investors should accept a higher risk for the hope of earning higher returns, at least when aiming to gain an exposure into the emerging world. Unquestionably, diversification effects remain the basis for investing in collective investment vehicles, and thereby the researcher encourages market participants to incorporate EM exposed securities into their portfolios. EMs can offer new investment opportunities to prospective investors, especially if careful consideration is given to the mutual funds’ characteristics analysed through the current research. Outstandingly, this work has shown that investors should not allow cost to be the deciding factor in selecting equity mutual funds, but rather to rationally elect the cheapest fund from a list of funds with an identical objective.