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A Study on Performance of Mutual Funds With special reference to Growth Plans and Dividend Plans

Submitted by RAJESH K . L .

Under the guidance of Dr. Paramashivaiah Department of Studies & Research in Business Administration Tumkur University

Submitted to Department of Studies & Research in Business Administration Tumkur University, Tumkur


Financial system in a country plays a dominant role in assets formation and intermediation, and contributes substantially in macroeconomic development. In this process of development mutual funds have emerged as strong financial intermediaries and are playing a very important role in bringing stability to the financial system and efficiency to resource allocation.

Mutual funds play a crucial role in an economy by mobilizing savings and investing them in the capital market, thus establishing a link between savings and the capital market. The activities of mutual funds have both short-and long-term impact on the savings and capital markets, and the national economy. A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial goal. The money thus collected is invested by the fund manager in different types of securities depending upon the objective of the scheme. These could range from shares to debentures to money market instruments. The income earned through these investments and the capital appreciation realized by the scheme are shared by its unit holders in proportion to the number of units owned by them (pro rata). Thus a Mutual Fund is the most suitable investment for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost.

The flow chart below describes broadly the working of a mutual fund:

The field of Mutual Funds, as an investing option, constantly grows in the global financial market, as well as in the Greek one. In the last years, which were characterized by the limiting of the performance of various alternative investments, mutual funds were established as one of the first choices of investors. Not only of those already keen on this type of investment, but also of new investors, which try for the first time their luck on a form of investment of less stable performance and with bigger percentage of risk. A mutual fund is a pool of commingled funds invested by different investors. Most mutual funds investors do not know each other and never have contact with each other (Francis, 32-1). The investment management of such a pool of funds is usually performed by a professional money management firm for a fee of around 1- percent of the market value of all the assets managed each year. Such managers invest the funds in a diversified portfolio of securities they research and analyze and expect to perform well. The owners of shares of the mutual fund may either invest more money or withdraw their money at any time. When a mutual fund investor withdraws funds, the action is called the redemption of shares. As soon as investors realize that a mutual fund is poorly managed, they should redeem their shares. The size of the total assets invested in a mutual fund changes continuously; the size shrinks with redemption and grows as more shares are sold (Francis, 1988).

The investment procedure on a mutual fund is a simple and quick matter and this explains why it is so popular and accessible way of investing internationally. Filling in a simple application and deposing the amount that we wish to invest in the bank account of the mutual fund we chose, names us automatically shareholder. The biggest, perhaps, advantage of the investment on mutual funds is that the invested amounts are not tied up. There is the choice of partial or total liquidation at any moment, with the filling in of a simple purchase application and after having paid the proper, according to the invested amount, fee. Depending on where they invest, the mutual funds can be divided in 4 categories: Growth funds seek high rates of return from capital gains undertake significant risks in order to earn these gains. Emerging growth stocks are sought. Growth and income funds seek both cash dividend income and capital gains and, as a result, are less risky than growth funds. Blue-chip stocks are common investments. Income and growth funds want to earn primarily cash dividends and, to a lesser extent, capital gains. Conservative blue-chip stocks, public utility stocks, and preferred stock are typical investments. Balanced funds claim to be in pursuit of income, growth and stability. Conservation of principal is placed above earning high returns. Public utility common stocks, preferred stocks, and high-grade corporate bonds are common investments.

Mutual funds are today one of the most popular tools in modern saving. Their main advantage, is the chance of each investor to follow every day at which point his investments are and to which direction their prices are moving when they change. Each mutual fund is described by three different values. The net value, which is the value of each share of the fund and derives from the division of the assets of the mutual fund with the number of shares which currently circulate. The disposition value, is the value that someone pays in order to buy shares of a fund. In other words, the price at which the company that is administrating the mutual fund sells its shares. This value, in most cases, is higher than the net value of the share. The difference between the net value and the disposition value, is the selling commission that receive the firms who are in administration of the mutual funds.

The purchase value shows how much money will someone receive if he decides to liquid one or more shares of a mutual fund. It is the price that the administrating firm pays for buying a share of the fund. The purchase value is usually lower than the net value and in no case higher. The difference between the two values- net and purchase-corresponds to the commission that receive the administrating firms during the liquidation of shares.

2. Background Of The Study

A Mutual Fund is the ideal investment vehicle for todays complex and modern financial scenario. Though it is an ideal vehicle people still think that Mutual Funds are very risky and cannot be trusted. The benefits of Mutual Fund are reaped by only certain cream of people of the society. This is due to lack of awareness about the benefits of investing in Mutual Fund.

In the current interest rate and inflation scenario, the returns on traditional investments avenues like bank deposits, post office saving schemes and RBI Bonds and ICICI and IDBI Bonds, Insurance along with evergreen investments options like Gold and Real Estates have gone up considerably or as volatile due to the global markets volatility and in the absence of stable interest scenario or the soft interest regime , mutual funds is definitely have an edge over other investment avenues due to the returns, liquidity and Service and transparency if one is looking at long term investments.

Hence its necessary that one should consider investing in Mutual funds as it has the potential for providing good returns along with diversification and also provides easy access to Capital markets and Secondary markets to a layman who cannot understand the complex financial markets.

3. Need and Importance of the Study

Over the years Indian Financial markets have changed drastically, due to the globalization. As a result a number of foreign investors have entered in Indian markets by way of NBFC, Banks and Mutual Funds.

Mutual funds play a crucial role in an economy by mobilizing savings and investing them in the capital market, thus establishing a link between savings and the capital market. The activities of mutual funds have both short-and long-term impact on the savings and capital markets, and the national economy.

Mutual funds have launched different schemes to suit and provide the safer and easier access to complex financial markets to a layman this research has been undertaken
Since there is high potential for Mutual Fund Investments there is a need to study the operational expertise, Advantages, performance , competitiveness , Tax effectiveness, transparency and Regulations. This study will help the investor to understand different types, modes of investment priorities and also to find out the return potential from Growth Plan and Dividend plan of different schemes of Mutual funds.

The decision-making process could break down into two separate stagesanalysis and timing. Because of the high leverage factor in the future markets, timing is especially crucial to successful trading. It is quite possible to be correct on the general trend of the market and still lose money. Because margin requirements are so low in future trading, a relatively small price move in the wrong direction can force the trader out of the market with the resulting loss of all or most of that margin. In stock market trading, by contrast, a trader who finds him or herself on the wrong side of the market can simply decide to hold onto the stock, hoping that it will stage a comeback at some point in the future. This is how many traders stop being traders and become investors.

The mutual fund industry has grown at an incredible rate in the past years, showing an explosive increase particularly over the last decade. However, the recent revelations about the expropriation of investors trust and wealth by mutual fund families have shaken investors confidence and have brought the mutual fund industry under a lot of scrutiny. So far, we have witnessed preferential treatment of certain clients when funds allowed them market timing and after hours trading. A legitimate question arises whether there have been other forms of preferential treatment that directly affect the observable performance of mutual funds. Towards that end, we ask whether mutual fund families can and indeed do affect the performance of their funds in a way that might systematically discriminate against certain investors.

One of the most extensively researched questions is whether mutual funds have persistent abnormal returns. If so, this provides evidence for the existence if superior managerial investment ability. In fact, persistence is well

documented. Lehmann and Modest (1987), Hendricks, Patel, and Zeckhauser (1993),and Wermers (1997), among others, have found evidence of persistence in fund performance over short horizons of one to three years. Yet, Brown and Goetzmann (1995) conclude that even if there is some predictability, it is quite dicult to detect. Carhart (1997), Daniel, Grinblatt, Titman, and Wermers (1997), Wermers (2000), and Pastor and Stambaugh (2002) argue that most of this persistence is due to factors other than managerial ability. In particular they show that positive abnormal returns can be attributed to momentum in stock prices, while negative abnormal returns can be attributed to managerial expenses and transaction costs.

In this paper we view mutual fund performance from a different perspective than the majority of the existing literature. Instead of treating a mutual fund as a completely independent entity, we view it as part of a larger group, the mutual fund family.

To test our hypothesis, we use monthly open-end mutual fund data from the Center for Research in Security Prices (CRSP) for the period of 1990-2002. Using a methodology similar to the one used by Carhart (1997) we analyze the persistence of the performance of mutual funds that belong to large families, defined either by the number of funds they hold or by their market capitalization. We find a short-term persistence in mutual fund performance. The difference in abnormal returns between a portfolio of funds which were last year's winners and a portfolio of funds which were last year's losers is 58 basis points per month (statistically significant at the 1% level), an annualized difference of 7.2%. In addition to these results, we perform the persistence methodology on a relative scale,i.e., when the funds are ranked with respect to their performance relative to other funds inside the same family. Again, we find a statistically significant difference between the top and bottom portfolio of 53 basis points per month, which translates into a difference of 6.5% per year in abnormal returns. The fact that persistence in fund performance is detected even within a mutual fund family

can be viewed as evidence that families are actively intervening in their funds' performance.

If the family wants to actively promote some funds over others, it can accomplish this by unequal resource allocation. Managers (analysts) are one of the main resources families have and one of the few resources that are observable. Chevalier and Ellison (1999a) and Chevalier and Ellison (1999b) show that personal characteristics of the fund manager can help predict superior stock picking ability. Families seem to place serious consideration on this fact, since their decision on managerial turnover is linked to the managers' past performance. Khorana (1996) and Khorana (2001) show that a low performance of at least two years is necessary before a manager is removed from the management of the fund. He also shows that in the post-replacement period there is a significant improvement in the performance of the fund. Fan, Hall, and Harvey (2000) analyze promotions and demotions of managers and conclude that there exists a positive relationship between past fund performance and the promotion of the fund's manager. All these findings indicate that mutual fund families take their fund management very seriously and are not reluctant to intervene in their funds' management, if needed. Hence, we can expect to observe family intervention which can potentially lead to preferential treatment of funds. In order to proxy an attempt from the family to push certain funds, we use the probability of adding another manager to a fund. If our hypothesis is wrong one would expect that after controlling for fund characteristics, there would no longer be any statistically significant difference in the probability of adding a manager between funds in different groups of performance ranking.

First, after using controls such as size and expenses, we ask if within rankings, the probability of adding another manager depends on abnormal returns and lagged abnormal returns. We find that only funds that were the previous year's top performers in their respective families, have a significant

positive coefficient for their alpha, which would indicate that the decision to add a new manager depends positively on the fund's performance only when it is among the top in its family. Second, we ask if the probability of adding a manager given the fund's past returns depends on the ranking group of the fund, i.e., on its relative performance against its peers in the same family. We find that the probability increases when a fund belongs to the top rank and decreases as the rank of the fund decreases. Lastly, we identify cases where only one manager was in charge of a fund and ask what the probability is of adding at least one new manager to such a fund. This question seems to be a more precise proxy for a deliberate action by the family, since changing the management of a fund from a single manger to a management team is more substantial than adding another manager to an existing team. We find that again, the probability increases when a fund belongs to the top rank and decreases when the fund belongs to the bottom rank.

The mutual fund industry has been one of the fastest growing sectors within the Canadian capital market over the past ten years. As shown in Table 1, the growth of the Canadian mutual fund industry has been remarkable. According to the Investment Funds Institute of Canada, as of June 2000, Canadians invested more than $400 billion in mutual funds -- more than ten times the total at the beginning of 1991. A survey in 1999 found that close to 40% of Canadians now own a mutual fund, an increase of 168% since 1991.1 The mutual fund industry has benefitted from a combination of low interest rates, the increasing age of the population, a growing large deficit in the Canada Pension Plan, the moving of savings from defined-benefit pension plans to defined-contribution plans, and an increasing awareness of mutual fund products over the past decade. 2

The purpose of these popular investment vehicles to provide professional management and the opportunity for investors to diversify. Each mutual fund within the larger fund complex is overseen by a board of directors which is responsible for carrying out the activities of the fund. The board of directors, in

turn, appoints a management company that chooses a portfolio manager which in turn determines the composition of the investment portfolio within the bounds set by the funds objective. Like other business organizations, there are two major forms of ownership structure of these management companies: partnership and corporation.

An interesting puzzle that exists in the industry is that some management companies choose to be publicly-traded on an exchange while others choose not to be. As of June 2000, there were approximately 200 companies managing mutual funds in the Canadian market and of those, seven were publicly-traded.3 Although the number of publicly-traded management companies is relatively small compared to the number of private management companies, they have been playing an important role in the Canadian mutual fund industry. More than 400 mutual funds were under management of these seven publicly-traded management companies as of June 2000. At the same time, the aggregate net asset value managed by these publicly traded management companies was approximately $155 billion which accounted for 40 percent of the total assets held by the Canadian mutual fund industry.4

The primary goal of this paper is to examine if the ownership of mutual fund management companies affects their performance. This is an important question since if indeed ownership and performance are related, investors should take this information into account when they decide in which mutual funds to invest. The link between the performance of mutual funds and the ownership of the management company is through the relationship between historical fund performance and the demand for funds by investors. This relationship has been examined by many authors in the literature and found to be quite strong, irrespective of the performance measure used.6 As the performance of the mutual fund increases, investors increase their holdings of the fund causing the net asset value (NAV) of the fund to increase. Since the management company receives a fixed percentage of the NAV, improved performance enhances the

flow of fees into the management company which, after expenses, accrues to the owners of the management company. To the best of our knowledge, the relationship between ownership and performance has not been examined for mutual fund management companies. The delegation of decision-making responsibility and the associated agency costs within the mutual fund complex are similar to those within the corporate structure typically studied in the literature. The major advantage of choosing mutual fund management companies when examining the ownership/performance relationship is that it allows us to control for the intra-industry heterogeneity across firms since the technology of the mutual fund management companies is quite homogenous across firms and only requires human capital. The restrictive regulations governing the mutual fund industry also dramatically reduces the companies' idiosyncratic characteristics.

Once the relationship between ownership and performance is established, we then examine how the ownership of mutual fund management companies affects their performance. Diffusion of ownership can affect performance in a number of ways. First, as Jensen and Meckling (1976) pointed out, managers of more diffusely held companies are expected to increase their excess perquisite consumption and thus increase the cost of production. A second effect of diffuse public ownership involves the risk-taking incentives of managers. Due to the difficulty of observing the expenditures of managers and the risk of the assets, previous researchers have not been able to differentiate between these two effects. The mutual fund management company provides us a rare opportunity to clarify this issue. For these firms, the link between ownership and manager expenditures can be directly observed through the administrative fees of the mutual funds. If publicly-traded management companies have greater excess perquisite consumption than private management companies, then the difference between the expense ratio and management fee, which includes the administrative fees, will reflect this phenomenon.

Further, unlike most other firms, the risk of the assets held by management companies can be easily measured. Because the assets of the management company consist of the mutual funds they manage, the risk associated with an investment in mutual funds can be calculated from the risk associated with their net asset value returns. There are two competitive arguments in the literature on how the concentration of ownership affects the managers risk taking behavior. The first argument, by Galai and Masulis (1976), is based on option price theory. The idea is that the greater is the concentration of ownership within firms, the greater is the incentive for the managers to maximize the shareholders value. Since equity can be viewed as a call option on the value of the firm with the amount of debt as the strike price, given the debt-toequity ratio, one way for the manager to increase the shareholders value is to increase the volatility of the underlying assets. Essentially, increasing the risk of the assets transfers wealth from the creditors to the shareholders. However, this argument is not relevant for mutual fund management companies since the fund companies typically have much less debt than other types of companies. Hence, the transfer of wealth effect through increasing the risk of the asset holdings may not provide the same benefit to the management companies shareholders as would be expected with more debt-oriented firms.

The second argument which is presented by Smith and Stulz (1985) is that the greater the managerial ownership, the more risk averse are the managers and hence they tend to adopt more hedging and other risk-reduction strategies. The reason is that the managers portfolio might not be well diversified and, therefore, as her ownership share increases, she has an incentive to reduce the riskiness of the firmss assets. In a recent paper, Zhang (1998) also showed that in the presence of a controlling shareholder within a firm, the underdiversified controlling shareholder is more averse to risky projects than would be the atomistic shareholders whose portfolios are more diversified. Using a sample of 302 depository institutions, Chenetal (1998) found that as the concentration of ownership increases, the level of risk taking decreases.7 Since neither the risk

reduction nor wealth transfer argument precludes the existence of the other effect, the relationship between ownership structure and risk taking behavior will depend on which effect dominates the other. As we note above, the wealth transfer effect might be quite weak in mutual fund industry due to its low debt feature, hence, it would be expected that the risk reduction effect is the dominant force for fund management companies. Consequently, the funds managed by publicly-traded managed management companies might have greater risk than do the funds managed by private management companies

At the same time, however, investing in risky assets increases the risk of the managers' portfolio since her income is based on the performance of the mutual funds she manages. In addition, investing in riskier assets usually requires greater effort on the part of managers. Therefore, publicly traded management companies must provide higher compensation for the managers due to both the greater risk and greater effort they undertake. Consequently, the publicly-traded management companies may charge a higher management fee than the private management companies. However, if publicly-traded

management companies are not able to provide sufficiently higher returns to compensate investors for the higher management fees, this might suggest that fund unit-holders should avoid mutual fund managed by the publicly-traded management companies.

The paper is organized as follows. Section 2 examines the governance structure within the mutual fund complex and compares it to that in the usual corporate entity. Section 3 discusses the data. Section 4 examines the performance of the mutual funds managed by the publicly-traded management companies and compares them with the mutual funds managed by the private management companies. Section 5 examines the factors which account for the difference in their performance while Section 6 is by way of summary and conclusions.

Indian financial institutions have played a dominant role in assets formation and intermediation, and contributed substantially in macroeconomic development. In this process of development Indian mutual funds have emerged as strong financial intermediaries and are playing a very important role in bringing stability to the financial system and efficiency to resource allocation. Mutual funds play a crucial role in an economy by mobilizing savings and investing them in the capital market, thus establishing a link between savings and the capital market. The activities of mutual funds have both short-and long-term impact on the savings and capital markets, and the national economy. Mutual funds, thus, assist the process of financial deepening and intermediation. They mobilize funds in the savings market and act as complementary to banking; at the same time they also compete with banks and other financial institutions. In the process stock market activities are also significantly influenced by mutual funds. There is thus hardly any segment of the financial market, which is not (directly or indirectly) influenced by the existence and operation of mutual funds. However, the scope and efficiency of mutual funds are influenced by overall economic fundamentals: the interrelationship between the financial and real sector, the nature of development of the savings and capital Markets, market structure, institutional arrangements and overall policy regime.

6. statement of the Problem To study the performance of selected mutual funds under equity, debt and balanced scheme for varied period on the basis of returns on the Growth and Dividend Plans.

Every investor wants to invest part of his income in various investment vehicles as a part of savings. There are many investment vehicles in which an investor can pool the money. Thus, mutual funds are also one of the investment vehicles in which investor can park certain amount as investment. A rational investor before going to invest wants to know how much return he can get from such investment. Hence its essential to measure the performance of the investment vehicles. Thus, measurement of performance of investment vehicle on the basis of return is one of the way to know how well the investment vehicle is performing over a period and how much return an investor can get. Mutual funds have launched different schemes to suit and provide the safer and easier access to complex financial markets to a layman . This research has been undertaken to study The Advantage of Growth Plans and Dividend Plan

with respect to Debt Mutual Funds and Equity Mutual funds

7. Objective of the Study

The main objectives of the research are To study the Different types of Mutual Funds. To study the performance of Equity & Debt Mutual Funds To Study the Advantage of Growth and Dividend Plans To Study the investment priorities & Tax Benefits

To provide the strategies to influence the investors to invest in mutual fund

8. Hypothesis of the Study

Keeping the above objectives in mind the researcher intends to test the following tentative hypotheses;

i . Dividend Plan is better than Growth Plan ii . Growth Plan is better only for the Debt Mutual funds

9. Scope of the Study

This study, given the top performing mutual funds gives an opportunity to know the top performer among the reputed mutual fund houses. However the Scope of the study is limited as it the comparison is mainly done on returns.

The performance of the mutual fund majorly depends on the following factors. portfolio structure , sector or segment exposure Quality of the management and the period.

However its difficult to study these factors, as many of the mutual fund houses will not disclose all these factors due to the competition among the fund houses and also the fund managers.

i. The study is confined to the only Equity , Balance and Debt Mutual Funds in Indian scenario

ii. Though he study is based on the historical data, the tax proposition is based on the returns and prevailing guidelines of Income Tax iii. The study will be conducted on the basis of performance during the period of 2007-2012
10. Data collection and Analysis

Sources of Data

i. Primary Data Primary data gathered from mutual funds fact sheets

ii. Secondary Data Extracted from companys book, through web sits of AMFI and other associate mutual Funds web sites , various journals etc.

iii. Tools and Techniques for Data Analysis Statistical tools and techniques used for data analysis are Tabulation Graphs Percentile calculation

11. Bibliography
Text Books Sadhak, H Mutual Funds in India, Sage Publications: Newbury Park AMFI Book Investment Policy & Performance of Mutual Funds M.Jayadev Mutual Funds Management and working Lalitb.k.Bansal The future of fund Management in India Tushar Waghmare

Journals & Magazines Investors Guide I.C.F.A.I Reader Dalal Street Smart Update