Mutual Fund Performance in Europe

Master Thesis
Mutual Fund Performance in Europe The Role of Fund Size
Moritz Felde ID 444650
Supervisor: Dr. Rogr Otten
Maastricht University Faculty of Economics and Business Administration Department of Finance The Netherlands
August 2007
List of Contents
LIST OF FIGURES............................................................................................................... III LIST OF TABLES................................................................................................................. IV 1 INTRODUCTION .................................................................................................................1 2 LITERATURE REVIEW .....................................................................................................4 2.1 US MUTUAL FUNDS ...........................................................................................................4 2.2 EUROPEAN MUTUAL FUNDS ..............................................................................................6 2.3 FUND SIZE .........................................................................................................................8 2.4 CONCLUSION ...................................................................................................................11 3 THE MUTUAL FUND MARKET .....................................................................................13 3.1 THE FRENCH MUTUAL FUND MARKET ............................................................................16 3.2 THE GERMAN MUTUAL FUND MARKET ...........................................................................17 3.3 THE ITALIAN MUTUAL FUND MARKET ............................................................................18 3.4 THE SPANISH MUTUAL FUND MARKET ...........................................................................20 3.5 THE UK MUTUAL FUND MARKET ...................................................................................20 4 DATA....................................................................................................................................22 5 METHODOLOGY ..............................................................................................................28 5.1 BENCHMARKS ..................................................................................................................28 5.2 PERFORMANCE MEASUREMENT .......................................................................................32 5.3 PORTFOLIO FORMATION ..................................................................................................34 6 TIME SERIES ANALYSIS ................................................................................................36 6.1 THE EFFECT OF FUND SIZE IN FRANCE ..............................................................................36 6.2 THE EFFECT OF FUND SIZE IN GERMANY ..........................................................................41 6.3 THE EFFECT OF FUND SIZE IN ITALY .................................................................................46 6.4 THE EFFECT OF FUND SIZE IN SPAIN .................................................................................50 6.5 THE EFFECT OF FUND SIZE IN THE UK ..............................................................................54 6.6 EXTREME PORTFOLIOS.....................................................................................................59 6.7 SMALL CAP FUNDS ..........................................................................................................63 6.8 SMALL FUNDS IN LARGE FUND FAMILIES ........................................................................65 7. ROBUSTNESS TESTS ......................................................................................................68 7.1 PERFORMANCE DEVELOPMENT ........................................................................................68 7.2 TIMING.............................................................................................................................71 7.3 SURVIVORSHIP BIAS ........................................................................................................74 7.4 OFFSHORE DOMICILE .......................................................................................................76 7.4 ACTIVE VS. PASSIVE ........................................................................................................78 8 CONCLUSION ....................................................................................................................79 REFERENCES .......................................................................................................................81
II
List of Figures
Figure 3.1 Figure 3.2 Figure 3.3 World Mutual Fund Assets by Region, 2006 .....................................................13 Total Net Assets of European Mutual Funds, 2006 in billion .........................14 The European Investment Fund Market Breakdown of Nationally Domiciled Funds, 2006 ........................................................................................................15 Figure 3.4 Figure 3.5 Per Capita Assets invested in Mutual Funds, 2006 in .....................................16 French Mutual Funds (retail and non-retail) under Management segmented by Type of Fund, 2001-2003 in m........................................................................17 Figure 3.6 German Mutual Funds (retail and non-retail) under Management segmented by Type of Fund, 1999-2003 in m........................................................................18 Figure 3.7 Italian Mutual Funds (retail) under Management segmented by Type of Fund, 1999-2003 in m................................................................................................19 Figure 3.8 Spanish Mutual Funds (retail and non-retail) Under Management segmented by Type of Fund, 1999-2003 in m........................................................................20 Figure 3.9 UK Mutual Funds (retail and non-retail) under Management segmented by Type of Fund, 1999-2003 in m .................................................................................21 Figure 4.1 Figure 4.2 Size Histogram of German Equity Mutual Funds, 2005 in m (large picture) .25 Size Histogram of German Equity Mutual Funds, 2005 in m (small picture).26
III
List of Tables
Table 4.1 Table 4.2 Table 4.3 Table 5.1 Table 5.2 Table 5.3 Table 6.1 Table 6.2 Table 6.3 Table 6.4 Table 6.5 Table 6.6 Table 6.7 Table 6.8 Table 6.9 Summary Statistics .............................................................................................23 Development of the average and median size fund from 1991 to 2005 in m..25 Investment Focus: Time-Series Averages of Cross-Sectional Averages ...........27 Summary Statistics for Benchmark Portfolios Domestic Funds .....................29 Summary Statistics for Benchmark Portfolios European Funds .....................30 Summary Statistics for Benchmark Portfolios Global Funds..........................31 Portfolio Returns France Domestic ....................................................................37 Portfolio Returns France Europe ........................................................................38 Portfolio Returns France Global.........................................................................40 Portfolio Returns Germany Domestic ................................................................42 Portfolio Returns Germany Europe ....................................................................43 Portfolio Returns Germany Global.....................................................................45 Portfolio Returns Italy Domestic........................................................................46 Portfolio Returns Italy Europe............................................................................48 Portfolio Returns Italy Global ............................................................................49
Table 6.10 Portfolio Returns Spain Domestic ......................................................................51 Table 6.11 Portfolio Returns Spain Europe..........................................................................52 Table 6.12 Portfolio Returns Spain Global...........................................................................53 Table 6.13 Portfolio Returns UK Domestic .........................................................................55 Table 6.14 Portfolio Returns UK Europe .............................................................................56 Table 6.15 Portfolio Returns UK Global ..............................................................................57 Table 6.16 Extreme Portfolio Returns France ......................................................................60 Table 6.17 Extreme Portfolio Returns Germany ..................................................................61 Table 6.18 Extreme Portfolio Returns Italy..........................................................................61 Table 6.19 Extreme Portfolio Returns Spain........................................................................62 Table 6.20 Extreme Portfolio Returns UK ...........................................................................63 Table 6.21 Small Cap Fund Returns.....................................................................................64 Table 6.22 Fund Family Returns ..........................................................................................66 Table 7.1 Table 7.2 Table 7.3 Table 7.4 Performance Development .................................................................................69 Timing (Henriksson and Merton (1981).............................................................72 Timing Treynor and Mazuy (1966) ....................................................................73 Test for Survivorship Bias ..................................................................................75 IV
Mutual Fund Performance in Europe The Role of Fund Size Table 7.5 Table 7.6 Table 7.7 Offshore Domicile ..............................................................................................77 Offshore Domicile Domestic Spread Portfolios .................................................77 Active/Passive ....................................................................................................78
1 Introduction
"You will see below-average expenses, high-quality management, diversified portfolios, and, of course, a long and generally successful track record." This quote, referring to the five largest equity mutual funds in the US, is from Russel Kinnel, director of mutual fund research at Morningstar. While Russel Kinnel stresses the advantages of large equity mutual funds, the performance history of Fidelity Magellan, formerly the worlds largest mutual fund, does not look very convincing. After the fund was closed to investors in 1997, its new portfolio manager Robert Stansky took control of a fund that was no longer manageable due to its enormous size (Nocera 1996). As a result, the unhealthy growth in assets under management is now regarded as the primary cause of the fund falling to fifth place in size in 2005. Prior, a record of poor performance led investors to pull out an estimated $ 11,6 billion from the fund between March 2004 and March 2005. Building on these two opposite outlooks on mutual fund size and its effect on performance, this study explores return differences between small and large mutual funds. Fund size has become of critical concern in Europe, more so since the EU enacted the first UCITS (Undertakings for Collective Investments In Transferable Securities) directive in 1985. Equipped with a so-called European Passport obtained in Europes mutual fund centre, Luxembourg, funds can be distributed in all EU member countries. Mutual funds managers are therefore able to reach a substantially larger number of customers compared to a purely national fund distribution. Thus, the question arises whether prospective advantages of larger mutual funds outweigh the potential disadvantages associated with fund size. Regardless of the qualitative viewpoint, one effect seems certain: Investors allocate money to those funds that have a convincing track record. Therefore, outperforming funds attract more capital than others resulting in the funds growing larger (Beckers &Vaughan, 2001). Apart from Russel Kinnel, numerous researchers and practitioners refer to advantages of fund size. The most obvious is the opportunity of large funds to profit from economies of scale. Fixed overhead expenses can be spread over a larger asset base, which might include costs for resources and research, among others. Normally, this should cause the costs per Euro invested to decrease and therefore result in a superior net performance. Additionally, Smith (1994) refers to larger funds being able to obtain more shares in 1
Mutual Fund Performance in Europe The Role of Fund Size oversubscribed IPOs than smaller ones. In contrast, other researchers point at potential diseconomies of scale for mutual funds. Perold and Salomon (1991) conjecture that diseconomies of scale stemming from the relation between market impact and transaction size, erode mutual fund performance. Equipped with a large asset base, fund managers lose the ability to quickly move in and out of positions. Not only does this reduce the fund managers flexibility, it also reduces the anonymity of trades. As Indro (1999) points out, large funds managers are carefully monitored by outsiders, who suspect managers to execute highly sophisticated deals. Therefore, investment intentions of large funds are quickly revealed. Apart from Otten and Bams (2002), previous research on fund size and its effect on performance focused on the US market. The purpose of this study is therefore to expand existing US studies on fund size and its influence on performance by investigating the European market. The main analysis in this study therefore aims to investigate whether large or small funds available for purchase in five European markets (France, Italy, Germany, Spain and the UK) display a better risk-adjusted performance. Within the course of this investigation, three models for estimating risk-adjusted returns are employed. The one-factor model by Sharpe (1964) and Lintner (1965) is augmented by Fama and Frenchs (1993) three-factor model as well as Carharts (1997) four-factor model. Additionally, two implications from a study conducted by Chen et al. (2004) are tested for the European market. First, it is examined whether the potentially eroding effects of fund size on performance are more severe for funds investing in small cap firms. Second, economies of scale for US mutual funds are believed to be found on the fund family level rather than on the individual fund level. This finding together with the assertion that large fund families face incentives to push their smaller funds yields the implication that small funds of large families should perform well. This second implication is also tested for the European fund market. The results of this study suggest that equity mutual funds in the four investigated continental European countries are on average able to expropriate economies of scale. Diseconomies of scale are found for UK equity mutual funds. As predicted by the liquidity hypothesis, diseconomies of scale are found for funds investing in small cap stocks, only. Apart from French funds exclusively investing in the small cap universe, smaller small cap funds outperform their larger peers in all investigated countries. By way of contrast, the second hypothesis from Chen et al. (2004), relating to small funds of large families outperforming their peers, is not supported by the data. 2
Mutual Fund Performance in Europe The Role of Fund Size The remainder of this paper is organized as follows. Chapter two presents an overview of the literature on which this research is based. Chapter three contains information on the worldwide, European and country specific mutual fund markets. Chapter four introduces the two datasets on which this study is based and presents a basic overview of descriptive statistics. In chapter five, the methodology as well as the different benchmarks in use are described. Chapter six presents an analysis on performance differences between large and small equity mutual funds, in chapter seven it is checked for robustness and chapter eight concludes.
2 Literature Review
This literature review attempts to depict an overview over a selection of seminal and influential studies in the area of mutual funds. Since all of the early and most of the recent works on mutual funds spotlighted the US market, this review starts out by reviewing the most important studies on this market. The subsequent sections will in contrast centre on studies on the European mutual fund market and on studies focusing on fund size, as these are the subjects which this study attempts to combine.
2.1 US Mutual Funds

Scholars have long attempted to asses the performance of mutual fund managers. While early studies are only able to make performance assessments on the basis of relative risk, the first academic to assess mutual fund performance in an absolute way is Jensen (1968). With the help of the capital asset pricing model developed by Sharpe (1964) and Lintner (1965), he is able to refer to performance that is attributable to risk. Everything beyond that is considered abnormal and has become known as Jensens alpha. The sample of 115 mutual funds in the period from 1945-1964 is on average not able to outperform market averages on a risk-adjusted basis. Furthermore, Jensen doubts whether any individual fund in the sample is able to do so. Other researchers such as Sharpe (1966) and Friend et al (1970) are in line with Jensens findings of mutual funds not being able to compensate for the costs of their operation. Although not generally contradicting these findings, Carlson (1970) points out that the question whether mutual funds outperform the market crucially depends on the time period of investigation and the market proxy used. A shortcoming of these studies was, according to Chang and Lewellen (1984) that the use of the single-factor capital asset pricing model used in the early studies fails to account for a fund managers ability to engage in macro market-timing-activities. In their study of 67 mutual funds between 1971 and 1979 they develop a statistical procedure incorporating the potential presence of market-timing by the fund manager. Nevertheless, the results they obtain show no qualitative difference to the previous ones. This is in accordance with Henriksson (1984), who finds that mutual fund managers are on average not able to successfully time the return on the market portfolio. According to Ippolito (1989), the entire first generation of papers relating to mutual fund performance is characterized by the joint conclusion of mutual funds 4
Mutual Fund Performance in Europe The Role of Fund Size performing poorly. In the very same paper, while performing a study comparable to the one of Jensen (1968), he obtains results contradicting prior findings. After having investigated a sample of 143 mutual funds during the period from 1964-1984, he finds that even net of fees and expenses mutual funds are able to generate an abnormal return of 0.81 per cent per year. When additionally investigating the effect of active investment strategies on turnover, fees and expenses, he finds that more active funds generate returns high enough to compensate for the higher costs they charge. Grinblatt and Titman (1989) in their study on quarterly portfolio holdings of a large sample of mutual funds also obtain results indicating that mutual fund managers do possess enough private information to generate abnormal gross returns. This effect is most pronounced for aggressive-growth funds, growth funds and funds with the smallest net asset values. Because these funds are also the ones charging the highest costs, Grinblatt and Titman (1989) do not find any category of funds to generate positive abnormal net returns. Malkiel (1995) criticises earlier research on mutual funds referring to the fact that these studies utilize datasets containing all mutual funds in existence at the time of the study. The bias associated with such a sample is called survivorship bias. He examines a sample of mutual funds between 1971 and 1991 free from survivorship bias and finds that the bias effect had previously been underestimated. In his performance analysis he finds mutual funds on average underperforming the market in net as well as in gross terms. Most strikingly, he finds no relationship between beta and returns within the framework of the capital asset pricing model. He thus concludes that most investors would be better off buying passive rather than active funds. Gruber (1996) poses the question why, after all that has been found out about mutual fund performance, investors still buy actively managed mutual funds. He explains what he calls the mutual fund puzzle with the help of a model in which he decomposes investors into groups with different skill and incentives. Wermers (2000) finds that most stocks held by mutual funds outperform the value weighted CRSP index. In aggregate he finds mutual funds outperforming the index by a yearly 130 basis points. By decomposing the 130 basis points into different parts, Wermers attributes 71 basis points to the stock picking talent of the fund managers. 55 to 60 stem from mutual funds picking stocks with characteristics associated with higher average returns than the benchmark. Nevertheless, because the outperformance of 130 basis points
Mutual Fund Performance in Europe The Role of Fund Size roughly equals the magnitude of the mutual funds expenses and transaction costs, they generate no abnormal net returns. Other studies emerging since the beginning of the 1990s have shifted their attention from performance to persistence. Hendricks, Patel and Zeckhauser (1993) investigate quarterly return data of a sample of no-load, open-end, growth-oriented equity funds from 1974 to 1988. They detect persistence in short-term superior fund performance and label this characteristic hot hands. If these hot hand funds are detected ex ante, risk-adjusted returns can be improved by 6 per cent per year. Moreover, the counterpart to hot hands, so-called icy hands is detected. Funds that underperformed in the previous period tend to underperform in the following period. These results are confirmed by numerous fellow scholars, among them Goetzmann and Ibbotson (1994) as well as Brown and Goetzmann (1995). Using a probit analysis, the latter find that poor performance increases the probability of a fund disappearing and that persistence stems mostly from those funds lagging the S&P 500. Moreover, the presence of persistence seems to depend on the time period of investigation. This latter finding is confirmed by Malkiel (1995) who finds strong patterns of persistence in the 1970s but is unable to detect them during the 1980s. While according to these studies, persistence seems to exist at least for certain time periods, Carhart (1997) attributes Hendricks, Patel and Zeckhausers (1993) Hot Hands momentum. He forms portfolios based on the funds lagged one year performance and assigns the difference in performance to common stock factors, expense ratios and transaction costs. Persistence is only detected in the underperformance of the two worst performing deciles of funds. He thus merely detects Icy and no Hot Hands.
2.2 European Mutual Funds

All of the above mentioned studies have one commonality: They solely focus on US American mutual funds. After all, the US mutual fund market has been extensively researched, while publications on European funds are scarce. In a study on performance persistence of European mutual funds, Grnbichler and Pleschiutschnig (1999) find persistence in risk-adjusted returns. Moreover, their finding stemming from an investigation of a sample of 333 European equity mutual funds is not weakened by the criticism of Carhart (1997). Neither employing the 4-factor model nor changing the technique to measure performance persistence mitigates their results. In a paper by Otten and Schweitzer (2002) the authors compare the US and the European mutual fund industry. The European sample, covering 506 funds for purchase in 6
Mutual Fund Performance in Europe The Role of Fund Size the five most important mutual fund countries ranging from 1991-1997, is restricted to domestically investing equity funds. With respect to performance the authors find that European mutual funds generate risk-adjusted returns superior to those of US mutual funds. Furthermore, small cap mutual funds in Europe as well as in the US outperform all other funds and their respective benchmarks. In the same year, based on data including the same number of funds but one more year of return data as in the previous study, Otten and Bams (2002) present a comprehensive overview over the European mutual fund industry. Contrary to what is found for the US market, they find positive and significant risk-adjusted gross returns in four out of five markets. Net of costs, mutual funds in these four markets on aggregate still perform better than the market. Moreover, this effect is significant for UK funds. With respect to performance persistence, the results of Otten and Bams (2002) contradict those of Grnbichler and Pleschiutschnig (1999). Apart from mutual funds in the UK, only weak evidence is found for performance persistence. Other studies on European mutual funds deal with individual countries, only. Dermine and Rller (1992) as well as Mc Donald (1973) focus on the French mutual fund industry. While the former investigate economies of scale and scope, the latter study focuses on the performance of only eight French mutual funds from the middle until the end of the 1960s. On average, these funds offered superior risk-adjusted returns. In a study on the German mutual fund market, Krahnen, Schmidt and Theissen (1997) investigate the performance of eleven domestically investing German mutual funds during the period 1987-1993. The authors find cross-sectional variation in performance, which results in changes in market share. An absolute performance measure is not within the scope of their study. This issue is instead covered in a very recent study by Stotz (2007). He performs a comprehensive performance evaluation study based on a sample of 141 funds during the period of 1989-2005. He estimates risk-adjusted returns using the CAPM based one-factor model of Jensen (1986) as well as Carharts (1997) 4-factor model. He finds a riskadjusted underperformance of 130 to 190 basis points for the average domestically investing, actively managed German equity fund. Nevertheless, fund managers investing in small-cap growth stocks with high momentum are able to generate positive though not significant Carhart alphas. With respect to mutual fund managers stock picking ability, Stotz (2007) thus arrives at the same sobering conclusion as other researchers based on the US fund market did. 7
Mutual Fund Performance in Europe The Role of Fund Size Cesari and Panetta (2002) study the performance of 82 Italian equity funds during the period 1985-1995. They find positive, risk-adjusted alphas of 7 to 109 basis points yearly, after CAPM estimation. However, based on net returns, Jensens alpha becomes close to zero and statistically insignificant. By the same token, Casarin, Pelizzon and Piva(2003) find no positive risk-adjusted net returns for Italian equity funds during the period of 19881999. Furthermore, only about ten per cent of the funds in their sample are able to generate positive and significant alphas. Quite recently, Vicente and Ferruz (2005) as well as Sainz, Grau and Doncel (2006) investigate the Spanish mutual fund market with respect to performance persistence and performance, respectively. The former investigate a sample of Spanish equity funds investing in the domestic market. While they found no added value in holding actively managed equity funds, they found strong evidence of contrary persistence in mean returns. This finding goes in the direction of Carhharts (1997) finding of gambling behaviour by some fund managers. Sainz, Grau and Doncel (2006) confirm Vicentes and Ferruz (2005) results of Spanish mutual funds not being able to generate positive abnormal returns. Moreover, the authors find no evidence of mutual fund managers being able to successfully engage in market timing. Blake and Timmermann (1998) study the UK mutual fund market. Based on a sample of 2300 UK Mutual funds in existence between 1972 and 1995, they find the average UK equity fund to underperform the market by 180 per year on a risk-adjusted basis. Fletcher and Marshall (2005), in their study on the performance of UK international unit trusts, find the average Jensen alpha to be negative and close to zero. While five out of six fund categories display non superior performance when compared to the benchmark, trusts investing in European countries perform superior to the benchmark, regardless of the model used.
2.3 Fund Size

The first scholars to find an effect that relates to the size of mutual funds are Grinblatt and Titman (1989). On the one hand, they hypothesize that small funds could outperform larger ones because their impact on security prices when moving in and out of securities is smaller. On the other hand, they anticipate larger funds could outperform smaller ones because of lower transaction costs and other economies of scale. When forming quintile portfolios based on the funds net asset values as of the beginning of their period of investigation, Grinblatt and Titman (1989) obtain results consistent with their first 8
Mutual Fund Performance in Europe The Role of Fund Size hypothesis. The smallest quintile of funds outperformed the other quintiles and is the only quintile that is able to maintain positive abnormal returns significant at the one per cent level. Even after controlling for the fact that the smallest quintile contains more aggressive growth and growth funds than the others, the size effect remains. However, the authors second hypothesis is also partly confirmed. Transaction costs are inversely related to fund size, eroding the effect of the smaller funds superior performance on a net return basis. Five years later, Grinblatt and Titman (1994) again investigate the same sample of domestically investing mutual funds as in their 1989 study. They use net asset value as one of five independent variables in a cross-sectional regression. By using two different benchmarks, the coefficient on the net asset value variable is negative but insignificant regardless of the benchmark in use. According to their second study, fund size has thus no effect on performance. Ciccotello and Grant (1996) obtained results in line with the previous studies on the effect of size on mutual fund performance. They investigate a sample of 626 mutual funds in the period of 1992-1992. Methodologically, they adopted Grinblatt and Titmans (1989) approach and sorted the funds in quintiles based on their net asset value at one specific point in time. They chose the end of their period of investigation to measure net asset value in order to test the first of their two hypotheses, stating that that a) large funds should have greater historical returns than small funds. They also follow Grinblatt and Titmans (1989) approach of measuring fund size as of the beginning of their period of investigation in order to test their second hypothesis stating that b) small funds should have greater future returns than large funds. Indeed, as predicted by hypothesis one, large funds outperformed small funds on the basis of past returns. This is in accordance with Becker and Vaughan (2001), who found that outperforming funds were able to attract significantly more money from investors than others. The second hypothesis, relating to a funds future returns is only partially confirmed by the data. Fund size has no effect on future fund performance except for funds with an aggressive growth investment objective. The authors denote this result intuitive, because logically the inflow of assets should pose a problem to a fund manager with limited investment choices. Within the framework of a pooled cross-sectional/time-series regression, Droms and Walker (1994) relate mutual fund performance to a large set of fund characteristics. Unlike the studies on size and performance previously mentioned, they investigate a sample of international funds available to US investors, not of domestically investing US funds. After having scrutinized 60 coefficients for asset size, the authors obtain a clear cut 9
Mutual Fund Performance in Europe The Role of Fund Size result: none of the coefficients is significantly different from 0. This lets them conclude that asset size is unrelated to the risk-adjusted returns on mutual funds in the US. Indro et al (1999) investigate a sample of 683 actively managed US mutual equity funds over the period 1993-1995. They are the first scholars to refer to a required minimum size of a mutual fund. Without a fund having reached a minimum net asset volume, the socalled break-even size of a fund, the cost of gathering and processing information are too high to be outweighed by returns. Moreover, the authors find declining marginal returns to information activities that become negative once a fund has reached a certain net asset volume. The authors attribute these diseconomies of scale to higher transaction costs on large purchases/sale orders, administrative stress, deviations from desired investment style, the opportunity costs of not implementing trades and the lack of the freedom to act without signalling intent. The central argument is that as a mutual fund attracts more and more money from investors, there are less investment opportunities left for him to take advantage of. In line with Indro et al (1999), Christopherson et al (2002) conjecture that there might exist an inverse relationship between net asset value and performance for small-cap investment managers. Their study contains data on small-cap managers, most of them offering a variety of products, not only mutual funds. The general problems connected with trading stock are, according to the authors, augmented when it comes to moving in and out of small-cap stocks. In the vein of previous studies, they sort managers into size quintiles. The methodological difference to previous studies lies in Christopherson et al (2002) grouping managers in quintiles in every sub period. By doing so, they control for the fact that well performing managers attract more capital than mediocre ones and are thus able to isolate an uncontaminated size effect. The analysis reveals that indeed there exists an inverse relationship between risk-adjusted performance of a small-cap manager and the level of assets under management and growth in assets under management, respectively. Hence, investors are urged to move out of small-cap investments once they have grown too large. Otten and Bams (2002) investigate the influence of fund characteristics on riskadjusted performance. They regress several fund characteristics on the funds four-factor alphas. Over all investigated countries, they observe a positive effect of size on riskadjusted performance and deduce that European mutual funds still have to grow to reach an efficient size. Nevertheless, the authors frankly admit that this finding might be biased by
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Mutual Fund Performance in Europe The Role of Fund Size self-induced correlation. This is the case if over-performing funds attract more capital from investors than other funds. Using a sample of mutual funds covering the extensive time period 1962-1999, Chen et al (2004) make use of the CAPM as well as the Carhart (1997) four-factor model to test the relation between fund size and performance. Their results reveal a statistically significant inverse relationship between fund size and performance. However, as the authors emphasize, the size effect is only visible while controlling for fund family size. A larger fund family size is associated with higher returns. This effect is attributed to larger fund families being able to realize economies of scale associated with trading commissions and lending fees. Because fund family size is positively correlated with fund size, the negative size effect would not be visible without controlling for fund family size. Inspired by the stipulations of the liquidity hypothesis stating that net asset volume should affect small cap investments more than others, the authors control for the size of the investment target. The results they obtain point to the confirmation of the liquidity hypothesis. While small-cap funds are largely affected by the adverse effect of size on their performance, the performance of large-cap funds is unaffected by the size of their asset base. Another interesting finding of Chen et al (2004) relates to the number of stocks held in the mutual funds portfolios. The median fund in the smallest size quintile held about 16 stocks, while the median fund in the largest quintile held about 66 stocks. In connection with the fact that the largest funds are many more than four times bigger than the smallest funds, this means that large funds on average have to take larger positions in individual firms than smaller ones. This lends further support to the unfortunate liquidity concerns for large funds. Recently, Chan et al (2005) present a study on the relation between fund size and the performance of Australian equity managers. Along the lines of previous research, they report a negative influence of fund size on manager performance. While digging deeper towards the origin of these diseconomies of scale, the authors receive results suggesting that high fund inflows exert purchasing pressure on the manager which results in him picking inferior investments and ultimately erodes performance.
2.4 Conclusion
The previous section portrays an overview of the various findings concerning performance and fund size in earlier studies. As the studies are arranged in a chronological
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Mutual Fund Performance in Europe The Role of Fund Size order, it becomes obvious that the research techniques have become more enhanced and results have become more sophisticated over time. In conclusion, some studies report an adverse relationship between size and performance, while others detect no effect at all. Nevertheless, all of the studies partitioning on a funds investment objective found fund size to negatively influence a funds risk adjusted returns. This is consistent with the liquidity hypothesis as it is stated in several of the abovementioned publications. As assets under management grow, fund managers seem to experience difficulties meeting sophisticated investment decisions.
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3 The Mutual Fund Market

In the year 1774, the Dutch merchant banker and broker Adriaan van Ketwich aspired to provide investment diversification opportunities also to those investors with limited means. He encouraged potential investors to subscribe to the Eendragt Maakt Magt and thereby laid the foundations for todays mutual funds. Despite this early attempt, the first mutual fund (Massachusetts Investors Trust) was established in Boston in the year 1924; exactly 150 years after Ketwich had the initial idea.1 Since then, the worldwide mutual fund industry looks back to a history of astonishing growth. In the USA, mutual fund assets amounted to $ 47,6 billion ( 34,9 billion) in the year 1970 and have grown to $ 10,4 trillion ( 7,6 trillion) in the year 20062. This corresponds to a yearly growth rate of roughly 16 per cent from 1970 to 2006. Moreover, the US mutual fund market accounts for 48 per cent of the worldwide $ 21,8 trillion ( 16 trillion) of assets invested in mutual funds. As can be seen from figure 3.1, Europe is the second biggest fund market with a share of 36 per cent of global assets, followed by Africa/Asia Pacific and the other Americas. Although the US fund market is the biggest fund market worldwide, its share of global mutual fund assets is steadily declining. While it accounted for 58 per cent of global assets in 1999, the other fund markets and especially the European market, have taken away some of the US global market share.
Figure 3.1 World Mutual Fund Assets by Region, 2006
Africa and Asia Pacific 12%
Other Americas 5% United States 48%
Europe 36%
Source: ICI
1 2
ICI 2007 Investment Company Fact Book Ibid, ICI 1996 Investment Company Fact Book, own computations
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Mutual Fund Performance in Europe The Role of Fund Size As described above, the European mutual fund market gains world wide market share. Moreover, European mutual funds net asset volume today accounts for almost 60 per cent when measured in relation to the GDP of the European Union (EU-15). This ratio amounted to app. 36 per cent in the year 2002 and documents the rapid growth in European mutual funds net asset value as compared to GDP.3 Net assets of European mutual funds are displayed in figure 3.2. While net assets under management declined after the bubble period from 2000 to 2002, the market grew continuously from 2002 to 2006. From 2005 to 2006 the market experienced a growth of 15,1 per cent and now amounts to almost 6 trillion of assets under management.4
Figure 3.2 Total Net Assets of European Mutual Funds, 2006 in billion
7000 5974 6000 5000 4000 3000 2000 1000 0 2002 2003 2004 2005 2006 3775 3338 4206 5189
Source: EFAMA
As presented in figure 3.3, mutual funds domiciled in Luxembourg, France and Germany together account for over one half of the European mutual fund market. Of these countries, Luxembourg is the most important country as a domicile for European mutual funds with a market share of 24,4 per cent. This huge rate seems at odds with Luxembourgs overall size relative to the other EU countries. When asked to comment on this apparent paradox, practitioners put forward several reasons to explain Luxembourgs importance in the European mutual fund market. First of all, the Luxembourg authority responsible for fund investments acts, the CSSF, is supposed to be quicker and more flexible than the national authorities in other EU member states. Furthermore, the CSSF is believed to be more liberal with respect to innovative products. As European fund markets are highly competitive, providers appreciate the quick and uncomplicated steps they are able to take in Luxembourg. Secondly, practitioners refer to potential economies of scale. The distribution of funds in
3 4
EFAMA Annual Report 2006-2007 This and the following numbers do not include non-UCITS funds
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Mutual Fund Performance in Europe The Role of Fund Size 27 EU member states is easier and cheaper if centrally organised in one country. Thirdly, registration in Luxembourg has various special advantages over the registration in single countries. This refers to less strict reporting standards as compared to the Netherlands and tax advantages as compared to e.g. the Netherlands or Germany. In the Netherlands for example, there used to be a capital tax on reclaiming dividends of 40 to 50 basis points which is absent in Luxembourg. Furthermore, trading in Luxembourg takes place only once a day, while in other European countries fund promoters have to report intraday NAVs. According to a practitioner from Barclays, this has the advantage of a more clear view on the in and outflows of a fund meaning that the day before you know what you will be selling the day after.5
Figure 3.3 The European Investment Fund Market Breakdown of Nationally Domiciled Funds, 2006
Sw eden 1,9% Sw itzerland 2,0% Austria 2,2% Spain 3,8% Italy 5,1% Ireland 9,5% UK 10,3% France 19,7% Germany 13,4% Belgium Denmark 1,7% 1,6% Others 4,5% Luxembourg 24,4%
Source: EFAMA
Apart from a comparison of fund domiciles by country, it is interesting to have a look at national European markets real size. Since Germany as the largest European member state counts about 176 times more inhabitants than Luxembourg does, it is clear that Luxembourg can not play a role in this comparison.6 By the year 2003, Germany was indeed the largest European fund market based on assets distributed, accounting for 27,1 per cent of the European Fund market. The Germans are followed by the French and the British, accounting for 25,2 per cent and 14,3 per cent of the European fund market, respectively. Of the European overall mutual fund market amounting to 5.974 billion of assets, the largest part is captured by equity funds, representing 44 per cent of the market. They are
5 6
All information referring to practitioners come from telephone interviews conducted February 2nd, 2007 CIA World Fact Book 2006
15
Mutual Fund Performance in Europe The Role of Fund Size followed by bond funds, capturing 24 per cent of market share and money and balanced funds, both representing 16 per cent of the market. Although not a major domicile of mutual funds, the UK plays an important role in the European equity-linked fund market. While the share of the other European countries (except Germany) in the equity-linked fund market is comparable to their share in the overall fund market displayed in figure 3.3, the UKs share in the equity-linked fund market (19 per cent) is almost twice as high as in the overall fund market. This happens on the expense of Germany, whose share of 6 per cent in the equity-linked fund market is less than half of its share in the overall mutual fund market. As can be seen from figure 3.4, there is still a large gap between most European countries per capita assets in mutual funds and the US. With 16.916, France comes close to the US per capita asset holdings of 20.573. Nevertheless, all of the other European countries per capita assets in mutual funds range below half of the US level. Obviously, the European mutual fund industry is in a huge backlog. This gives reason to expect further growth in the industry and an augmentation of mutual funds influence on the development of capital markets.
Figure 3.4 Per Capita Assets invested in Mutual Funds, 2006 in
25000
20573
20000
16916
15000
9517 5572 5700 6199 6511 9535
10000
4492
5000
Ne th er la nd s G er m an y
Sp ai n
ly Au st ria Sw itz er la nd Fr an ce
Source: BVI
3.1 The French Mutual Fund Market

As mentioned in the previous section, the French mutual fund market is the second biggest in Europe. With respect to the type of funds held in France, the large share of money market funds is remarkable. As displayed in figure 3.5, the share of money market funds 16
US A
UK
Ita
Mutual Fund Performance in Europe The Role of Fund Size during the period 2001-2003 ranged between 42 per cent and 48 per cent of total assets held in mutual funds. This huge share is especially noteworthy considering the unfavourable taxation of short-term investments as compared to long-term investments until the year 2002.
Figure 3.5 French Mutual Funds (retail and non-retail) under Management segmented by Type of Fund, 2001-2003 in m
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Equity Money Market Bond Balanced Other Unsegmented Offshore Funds Property (n/a)
2001
2002
2003
Source: Datamonitor
Of all the distribution channels for mutual funds, banks are by far the most important ones. In 2003, 80 per cent of French mutual funds are distributed by banks. The remaining 20 per cent are almost evenly split between insurers and independent distributors. When segmenting the fund market by distributor, the huge diversity of the market in France becomes apparent. About seven key players, among them BNP Paribas or AXA, control about two thirds of the market. This makes the French market the second most diversified one in Europe after the UK. However, ranked by performance, four out of five of the best fund groups controlled less than five funds. This effect is due to a huge number of smaller foreign promoters who had to open up funds domiciled in France in order to compete with domestic promoters. In fact, these promoters were forced to do so for otherwise unfavourable tax conditions. Of all the five European countries under consideration, France has the smallest share of equity funds in the market. What is more, this share declined between 2001 and 2003, reflecting the drop in equity prices and a more security-oriented investment strategy.
3.2 The German Mutual Fund Market

Germany has the largest mutual fund market in Europe. Akin to other European fund markets, assets under management in the German mutual fund market declined during the 17
Mutual Fund Performance in Europe The Role of Fund Size period 2001-2002 but experienced steady growth since then. As presented in figure 3.6, the balanced fund market accounted for the largest stake in the market. They are followed by money market and equity funds which, as in France, only account for a small share of all assets invested. Their relative stake declined between 2000 and 2002 in reaction to the equity price drop and investors longing to decrease their exposure the equity markets.
Figure 3.6 German Mutual Funds (retail and non-retail) under Management segmented by Type of Fund, 1999-2003 in m
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Equity Money Market Bond Balanced Other Unsegmented Offshore Funds Property
1999
2000
2001
2002
2003
Source: Datamonitor
The lions share of the funds sold in Germany is sold by Banks and ranged between twothirds and three-quarters from 2000 to 2002. While the rest of the market is mostly shared between independent intermediaries and insurers, the latter suffer from a decrease of more than 50 per cent of market share from 2000 to 2002. Furthermore, almost unrecognized a few years ago, investment companies attempt to gain market share in the German mutual fund sector and accounted for a share of about 5 per cent in 2002. About 60 per cent of the German mutual fund market is controlled by 5 key players. Among them, DWS and DEKA together account for 40 per cent of the German market. Since they both belong to huge Banks, they profit from a huge branch network triggering the distribution of mutual funds. Compared to other European mutual fund markets such as the UK, France or Italy, the German market is quite concentrated. As in the case of France, fund groups with a smaller number of funds in the portfolio did extremely well over the last years.
3.3 The Italian Mutual Fund Market

With a compound annual growth rate of -7,1 per cent, the Italian mutual fund market was the worst performing market in Europe over the period 2001 to 2003. 18
Mutual Fund Performance in Europe The Role of Fund Size Similar to other European markets, the largest decline in mutual fund assets is found in the equity segment. While this is a reaction to decreasing equity prices throughout all European markets between 2000 and 2002, the increase in equity assets of 5 per cent in 2003 is again very low. As money was withdrawn from equity accounts, people began to invest more money into secure investments like money market funds. These funds experienced an increase in assets under management of 421 per cent during the period 1999 to 2003. This is why the Italian retail money market fund market and the traditionally strong bond fund market are the largest of their category in Europe.
Figure 3.7 Italian Mutual Funds (retail) under Management segmented by Type of Fund, 1999-2003 in m
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Equity Money Market Bond Balanced Other Unsegmented Offshore Funds Property(n/a)
1999
2000
2001
2002
2003
Source: Datamonitor
Although still the most important distribution channel for mutual funds in Italy, Banks are steadily losing market share to other participants like intermediaries. The so-called mixed system accounts for a market share of 40 per cent, almost as much as banks with a market share of 49 per cent. The fund market in Italy is very fragmented with the largest player (Nextra Investment Management) accounting for a small 19 per cent of the total market. Other smaller and medium size players control 49 per cent of the market while the remaining 32 per cent are left to smaller suppliers of mutual funds. Larger fund promoters have in contrast to other European markets been very successful in Italy. Between 1999 and 2003, none of the fund groups holding less than five funds in the portfolio has more than once appeared in the top five between 1999 and 2003.
19
3.4 The Spanish Mutual Fund Market

After a three year period of declining assets, the year 2003 marked a 21 per cent increase in assets within the Spanish mutual fund sector. While the share of balanced and equity funds declined during the period of weak stock markets from 2000-2002, the money market segment remained stable at about 25 per cent of the total market.
Figure 3.8 Spanish Mutual Funds (retail and non-retail) Under Management segmented by Type of Fund, 1999-2003 in m
1999
2000
2001
2002
2003
Source: Datamonitor
The fund distribution in the retail segment lies almost exclusively within the hands of banks. In the year 2003, banks and savings banks together distributed 91,8 per cent of assets in the mutual fund sector. Brokers cover the remaining bit of the Spanish retail market. Among banks two key players dominate the distribution of Spanish mutual funds. Santander Gestion de Activos and BBVA Gestion account for a combined market share of 46 per cent. In comparison to other European mutual fund markets, this is a high concentration for the two top players. However, the remaining market is quite dispersed with none of the other distributors accounting for a market share of more than 6 per cent. In four out of five years between 1999 and 2003, the best performing fund promoter had less than five funds in the portfolio. This effect is not unique in the Spanish market and seems to be a Europe wide phenomenon.
3.5 The UK Mutual Fund Market

The UK mutual fund market is in many aspects different from the continental European mutual fund markets. Over the period from 1999 to 2003, the British fund market experienced a decline in assets under management. The compound annual growth
20
Mutual Fund Performance in Europe The Role of Fund Size rate of -1,7 per cent over that period means that the UK fund market was the second worst performing one in Europe over that period. The depressing performance of the UK mutual fund market over that period mainly originates in the stock markets downturn during those years. As exhibited in figure 3.9, the mutual fund markets development is highly dependent on the development of the stock market. In fact, 93 per cent of the decrease in overall UK mutual funds between 2000 and 2002 was driven by equity funds. With an equity exposure of about two-thirds, the UKs mutual fund market has by far the highest equity exposure of all European countries. Of the countries investigated, Italy had Europes second highest equity exposure in 2003, amounting to 27,9 per cent of total assets invested in mutual funds. This is still more than two times smaller than the UKs relative equity stake in its mutual fund market.
Figure 3.9 UK Mutual Funds (retail and non-retail) under Management segmented by Type of Fund, 1999-2003 in m
1999
2000
2001
2002
2003
Source: Datamonitor
Another peculiarity about the UK mutual fund market concerns the distribution channels. While Banks are responsible for the majority of mutual fund assets distributed in continental Europe, they do not play a role in the UK. Instead, independent intermediaries distribute about two thirds of the mutual funds in the UK. Direct distribution, private client distribution and sales force tied agents share the rest of the UK mutual fund market. Distribution in the retail segment, which accounts for roughly one-half of the overall British mutual fund market, is very fragmented. The market leader Fidelity Investment has a stake of only 8 per cent of the fund market, while the majority of the funds are distributed by providers having less than 3 per cent market share. Hence, the UK market is the most fragmented of all markets under investigation.
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4 Data
Within the framework of this study, two different datasets are used and combined. They are both generously provided by Dr. Rogr Otten. The first dataset is supplied by Lipper and contains monthly observations of equity mutual fund returns from January 1992 to March 2006. Included are equity mutual funds listed in France, Germany, Italy, Spain and the UK. The dataset is free form survivorshipbias because it not only contains live equity mutual funds but also those that were previously merged or liquidated. Funds with less than twelve months of data are not contained in the sample and returns are inclusive of distributions and net of fees. Returns for each fund in the sample are originally displayed in the funds respective reporting currency. Since this study attempts to take the view of a European investor, all returns are converted into Euro. This is done by application of the interest rate parity. Furthermore, discrete returns are converted into lognormal returns by utilization of the formula Ln return = Ln (discrete return +1). The second dataset consists of annual observations of cross sectional data on live equity mutual funds listed in France, Germany, Italy, Spain and the UK. Unlike the first dataset, observations in the different countries in the second dataset refer to different periods of time. While the dataset displays observations of 40 fund characteristics from 1991 to 2005 for France and Italy, it only contains a limited number of years for Germany (1995 to 2005) Spain (1995 to 2005) and the UK (1996 to 2005). For the purpose of this study, the characteristic closing net asset value is most important. It is stated in absolute monetary terms and builds the basis for portfolio formation later on. However, this process will be described in detail in the next chapter. Since this study attempts to investigate the effect of fund size as measured by the net asset value of a fund on performance, the two before mentioned datasets are combined. For the matching procedure, funds are first matched on the basis of their names, then on the basis of their ISIN numbers. The resulting merged dataset is the one used in this study. However, the merged dataset is not free of survivorship-bias. Unfortunately, the crosssectional dataset only contains data on funds in existence in the year 2005. Most likely, underperforming funds have been the ones shut down in the past. This is why the merged dataset is likely to overestimate actual returns. Unless indicated differently, this study exclusively relies on the matched dataset.
22
Mutual Fund Performance in Europe The Role of Fund Size Table 4.1 exhibits summary statistics of the merged equity mutual fund sample. Most data is available for funds distributed in Germany. With a total number of 2434 funds it offers a broad basis for a performance analysis. Unfortunately, the UK fund sample is limited to merely 1089 funds. This is due to the cross-sectional database containing only 1445 UK funds. Additionally, merging the UK datasets comes with a second peculiarity. While 22 per cent of the UK funds in the return database invest domestically, this ratio doubles once the datasets are merged. Hence, 43 per cent of UK funds in the merged sample invest in domestic stocks. Apart from the total number of funds contained in the dataset, table 4.1 exhibits the average number of funds. It accounts for the fact that not all funds included in the database exist in every year of the sample period. Especially in the early years of the sample period the number of funds for which data is available is very low. Fortunately, the number of UK funds is quite stable throughout the years. Therefore, problems connected to the low absolute number of funds are somewhat mitigated.
Table 4.1 Summary Statistics Total Number Average Number Excess Return Std.Dev. France All Funds 1815 1046,4 2,91% 20,28% Global ex Europe 927 546,2 1,35% 21,57% Europe ex Domestic 673 358,2 4,91% 19,87% Domestic 215 140,3 4,61% 21,31% Germany All Funds 2434 1308,4 3,60% 21,36% Global ex Europe 1495 799,2 2,33% 22,58% Europe ex Domestic 832 440,1 5,98% 20,56% Domestic 107 76,2 4,23% 25,25% Italy All Funds 1613 823 1,69% 19,64% Global ex Europe 1023 509,3 0,10% 21,39% Europe ex Domestic 493 254,3 3,86% 19,23% Domestic 97 56,2 5,59% 18,95% Spain All Funds 1701 877,8 1,94% 20,41% Global ex Europe 1014 517,6 0,49% 22,89% Europe ex Domestic 562 293,2 4,01% 19,63% Domestic 125 66,5 4,44% 18,62% UK All Funds 1089 698,1 5,56% 20,37% Global ex Europe 495 320,6 3,97% 22,31% Europe ex Domestic 129 87 8,34% 20,76% Domestic 465 290,3 6,57% 19,26% Summary statistics for the merged sample. Sample period is from January 1992 to March 2006. Funds are separated by country of distribution and geographical investment focus. Excess returns are in excess of the risk-free rate, lognormal, annualized, expressed in Euros, and net of expenses. For each portfolio, returns are calculated as equal-weighted average returns of all funds in a portfolio. Standard deviations are also annualized.
The lognormal net excess returns presented in column three demonstrate large differences by country and geographical investment focus. They range from 0,1 per cent for Italian 23
Mutual Fund Performance in Europe The Role of Fund Size globally investing stocks to 8,34 per cent for UK funds with a European investment focus. Throughout all five countries, investments in equity mutual funds with a global investment focus yielded the lowest excess returns. Risk as measured by the standard deviation of excess returns ranges from 18,62 per cent for domestic Spanish funds to 25,25 per cent for domestic German funds. Overall, risk differences across countries and investment focuses are quite small. Table 4.2 displays the size of the average fund as well as the size of the median fund for each year. The relation between the size of the average fund as calculated with the arithmetic average to the median funds size is the same in all five countries. The median fund is much smaller throughout all years under investigation. The ratio of average fund size divided by median fund size varies from 1,6 to 4,9 and indicates that the distribution of size is skewed. Some very large players seem to drive up the size of the average fund. When investigating this further, this hypothesis is confirmed. In Germany 2005, the largest fund (Fidelity European Growth Fund A) is more than 3 times larger than the second largest fund (Templeton Growth Euro A Acc). Furthermore, the largest fund is more than 13 times larger than the tenth largest fund (Union Uni Europa). The corresponding ratios in the other continental European countries are of the same size. In the UK these numbers are considerably smaller, largest divided by second largest yields a ratio of 1,5, while largest divided by tenth largest yields a ratio of 5,4. As an example for the extreme skewness, a histogram of the size distribution for the German market in 2005 is provided in figure 4.1. About 81 per cent of the funds have a net asset volume of less than 250 million . As depicted in figure 4.2, 58 per cent of the mentioned 81 per cent are even smaller than 50 million . This means that almost one half of the funds in the German market 2005 are smaller than 50 million . To put that into perspective, almost 50 per cent of the funds are more than 319 times smaller than the largest fund (Fidelity European Growth Fund A) in the sample. Patterns of size increases and decreases are similar throughout all five countries. The average and median fund size increases monotonically from 1991 to 2000. The only exceptions are the UK, where the average and median equity mutual funds net asset volume already declines from 1999 to 2000 and Italy, where it decreases from 1991 to 1992. From 2000 to 2002, net asset volume of the average and median fund decreases in France and Spain. After 2002, net assets in these countries continue to increase. In Germany, Italy and the UK, net assets of the average and median fund decrease one more
24
Mutual Fund Performance in Europe The Role of Fund Size year, from 2000 to 2003. Subsequently, the average and median funds net assets continue to rise in these three countries.
Table 4.2 Development of the average and median size fund from 1991 to 2005 in m
France Ave. Size Median Size 6,93 3,47 16,03 5,87 40,86 17,89 60,40 29,29 63,36 29,59 79,07 43,22 108,69 59,64 118,56 53,18 201,15 91,25 298,32 113,25 196,90 59,36 148,46 39,98 148,63 45,88 181,22 52,31 321,30 84,13 Spain Ave. Size Median Size n/a n/a n/a n/a n/a n/a n/a n/a 61,94 36,39 70,48 43,53 102,43 61,05 130,23 66,37 171,83 96,10 277,78 106,06 201,96 62,96 107,96 32,36 118,02 36,08 156,35 44,71 277,32 78,73 Germany Ave. Size Median Size n/a n/a n/a n/a n/a n/a n/a n/a 61,68 34,86 94,57 41,39 133,74 52,03 163,23 53,46 228,85 77,28 299,91 91,84 207,23 57,92 149,59 41,70 143,46 39,40 174,75 49,09 209,32 58,70 UK Median Size n/a n/a n/a n/a n/a 78,61 65,99 66,61 85,90 81,49 57,67 47,35 46,12 50,25 49,48 Italy Median Size 4,74 6,32 19,41 28,98 34,68 46,79 77,87 78,18 105,42 129,35 84,64 52,78 50,27 56,88 62,74
Year 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Ave. Size 23,04 17,16 50,77 63,49 70,11 85,05 133,62 169,08 274,19 329,85 228,54 158,73 156,38 188,13 225,11
Year 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Ave. Size n/a n/a n/a n/a n/a 135,26 178,92 193,44 229,82 218,08 179,45 145,76 125,64 145,32 165,55
Figure 4.1 Size Distribution of German Equity Mutual Funds, 2005 in m (large picture)
450 400 350 300 250 200 150 100 50 0 < 250 250 - 500 500 - 750 750 - 1000 1000 2000 > 2000 48 20 9 16 410
Note: The horizontal axis displays the funds size in million. The vertical axis displays the number of funds that belong to a certain size category as specified by the horizontal axis.
25

Figure 4.2 Size Distribution of German Equity Mutual Funds, 2005 in m (small picture)
250 200 150 100 50 0 < 50 50 - 100 100 - 150 150 - 200 200 - 250 81 29 29 33 238
Note: The horizontal axis displays the funds size in million. The vertical axis displays the number of funds that belong to a certain size category as specified by the horizontal axis.
While the average and median funds size is of comparable size in the continental European countries, UK funds are different. They used to be much larger than their continental European counterparts prior to 1999. However, the average and median funds size in 2005 is considerably smaller in the UK than in the continental European countries. This means that the size differences over time among UK equity mutual funds are much less volatile than in the other countries. The reason for this might be that the UK equity mutual fund market is much more mature and looks back to a much longer history than the other markets. However, a deeper analysis of this finding is beyond the scope of this study. Table 4.3 exhibits equity mutual funds geographic investment focuses per country. Displayed are time-series averages of cross-sectional averages. In the four continental European countries most equity mutual funds invest with a global focus, while roughly every seventh fund in these countries invests with a European perspective. These funds are followed by funds investing in the USA and by those investing in Japan. Between eight and ten per cent of the funds invest in the USA and between seven and nine per cent of the fund invest in Japan. In France, Germany and Italy, the domestic market is the fifth most invested in. This means that in the continental European countries, a relatively small share of funds is confined to domestic investment. About every 20th fund offered in these countries invests in domestic stocks, only. Equity mutual funds investing in the ten most popular investment regions constitute between 74 per cent (Spain) and 79 per cent (France) of all funds sold in the respective countries. The remaining funds not listed in table 4.3 mainly invest in regionally very constrained, smaller and thus less liquid markets such as Korea, Malaysia or Norway.
26
Mutual Fund Performance in Europe The Role of Fund Size Once more, the picture looks different in the UK. Over 40 per cent of the UK funds in the sample invest in the domestic market. Other investment focuses such as Global, Europe or Japan are represented in roughly the same proportions as in the continental European countries. Furthermore, the UK market is more concentrated than the four other markets under investigation. Equity mutual funds investing in the ten most popular investment regions account for 97 per cent of all UK funds in the sample. Hence, only a very small fraction of UK funds invests in investment regions different from the most popular ones.
Table 4.3 Investment Focus: Time-Series Averages of Cross-Sectional Averages
France Global Europe United States of America Japan France Eurozone Asia (ex-Japan) United Kingdom North America Global Emerging Markets Spain Global Europe United States of America Japan EuroZone Spain Asia (ex-Japan) North America United Kingdom Global Emerging Markets 16,33% 15,68% 9,53% 8,29% 6,14% 6,10% 4,55% 4,24% 4,15% 4,05% Germany Global Europe United States of America Japan Germany Asia (ex-Japan) Global Emerging Markets North America United Kingdom EuroZone UK United Kingdom Global Europe exc UK Japan North America Far East United States of America Europe Global Emerging Markets Asia (ex-Japan) 22,40% 15,67% 9,16% 7,86% 5,72% 4,96% 3,87% 3,81% 3,22% 3,17% Italy Global Europe United States of America Japan Italy Asia (ex-Japan) North America Global Emerging Markets EuroZone Asia Pacific 20,09% 15,14% 8,85% 8,35% 6,40% 5,10% 4,75% 4,54% 3,51% 2,55%
17,91% 13,87% 9,06% 8,59% 5,54% 4,37% 4,23% 3,71% 3,71% 3,26%
43,35% 16,56% 9,37% 7,34% 4,58% 4,21% 4,10% 3,28% 2,53% 2,01%
Note: This table reports summary statistics for the funds contained in the sample. Reported are time-series averages of cross-sectional averages of the funds regional investment focus. Sample periods differ by country and are the same as reported in table 4.1.
27
5 Methodology
Methodologically, previous studies investigating the effect of fund size on performance such as Grinblatt and Titman (1989) or Ciccotello and Grant (1996) define fund size as stationary. However, several disadvantages are connected to this method. First, defining size as stationary goes along with the implicit assumption that neither the mean nor the variance of the size distribution change over time. With respect to equity mutual fund size, this assumption is not realistic. Second, mutual funds should attract more capital than their peers if they outperform them and vice versa. This means that funds are larger because they performed better in the past. In their 2002 study, Otten and Bams refer to this effect as self-induced correlation, meaning that size and risk-adjusted performance are potentially positively correlated when looking backwards. This study takes the attempt to circumvent this problem as described in the next section. Subsequently, the various performance benchmarks will be described and discussed.
5.1 Benchmarks
In order to estimate risk-adjusted returns for the equity mutual fund sample, this study relies on the Capital Asset Pricing Model (CAPM) of Sharpe (1964), the three-factor model of Fama and French (1993) and the four-factor model by Carhart (1997). In order to construct these models, performance benchmarks are needed. They are an approach to account for heterogeneity in fund styles. Market proxies are constructed by Dr. Rogr Otten and obtained from the Worldscope universe of the respective country. All stocks that are larger than $25 million are considered. Five different market proxies are used in this study, each reflecting different geographical investment focuses. In a second step, the local risk-free rate as proxied by the one-month interbank rate is subtracted from the market. Thus, for each of the following investment focuses a distinct market proxy is employed: Global, Europe, France, Germany, Italy, Spain and the UK. Since the risk-free rate is different in each country, 15 different time-serieses of excess market return are obtained. Apart from the market proxies, factor mimicking portfolios are constructed in order to account for style specific returns. While some scholars like Fama and French (1993) attribute these returns not to a specific style but to risk, a comprehensive discussion of the factors correct interpretation is beyond the scope of this study. All stocks within an investment region are sorted by size in order to calculate SMB. SMB is the difference between the returns on a portfolio containing large stocks minus the returns on a portfolio 28
Mutual Fund Performance in Europe The Role of Fund Size containing small stocks. In order to calculate HML, stocks are ranked according to their book-to-market ratio. HML is the return differential between a portfolio containing the top 30 per cent of stocks with respect to the book-to-market ratio and the bottom 30 per cent of stocks with respect to the book-to-market ratio. For the formation of the European MOM factor, this study follows Rouwenhorst (1998) instead of Carhart (1997) and first ranks stocks based on their prior 6-month return. MOM is the return differential between a portfolio containing the top 30 per cent of stocks with respect to the past 6-month return and a portfolio containing the bottom 30 per cent of stocks with respect to the past 6-month return. In order to obtain a rolling momentum factor, these portfolios are rebalanced monthly. Tables 5.1, 5.2 and 5.3 report summary statistics for the various portfolios that are comprised in the performance benchmarks.
Table 5.1 Summary Statistics for Benchmark Portfolios Domestic Funds Panel A: France Domestic Monthly Cross-Correlations Factor Excess Std t-stat for Portfolio Return Dev Mean = 0 Market SMB HML MOM Market -0,63% 5,78% -0,75 1,00 SMB 0,75% 2,74% 1,90 -0,34 1,00 HML 0,72% 4,11% 1,21 0,38 0,08 1,00 MOM 0,32% 6,97% 0,32 -0,71 0,34 -0,44 1,00 2001/1 - 2004/12 Panel B: Germany Domestic Monthly Factor Excess Std t-stat for Cross-Correlations Portfolio Return Dev Mean = 0 Market SMB HML MOM Market -0,02% 6,06% -0,02 1,00 SMB 0,09% 4,26% 0,19 -0,79 1,00 HML 0,99% 6,30% 1,33 -0,12 -0,09 1,00 MOM -0,56% 8,84% -0,54 -0,20 0,24 -0,71 1,00 1999/1 - 2004/12 Panel C: Italy Domestic Monthly Factor Excess Std t-stat for Cross-Correlations Portfolio Return Dev Mean = 0 Market SMB HML MOM Market -0,49% 5,51% -0,62 1,00 SMB 0,14% 2,30% 0,43 -0,23 1,00 HML 0,62% 3,65% 1,18 -0,24 0,48 1,00 MOM 0,16% 5,64% 0,20 -0,62 0,38 0,36 1,00 2001/1 - 2004/12 Panel D: Spain Domestic Monthly Cross-Correlations Factor Excess Std t-stat for Portfolio Return Dev Mean = 0 Market SMB HML MOM Market 0,10% 5,47% 0,12 1,00 SMB 1,07% 3,26% 2,27 -0,65 1,00 HML 0,59% 4,39% 0,93 -0,35 1,00 MOM -0,29% 5,79% -0,35 -0,76 0,68 0,35 1,00 2001/1 - 2004/12
29

Table 5.1 Continued UK Domestic Monthly Cross-Correlations Factor Excess Std t-stat for Portfolio Return Dev Mean = 0 Market SMB HML MOM Market 0,36% 4,69% 0,76 1,00 SMB 0,58% 3,99% 1,43 0,38 1,00 HML 0,22% 4,26% 0,51 0,21 0,04 1,00 MOM 0,46% 6,26% 0,72 -0,04 0,27 -0,55 1,00 1999/1 - 2005/12 Summary statistics for loadings of the four fund portfolios sorted on different factors and separated by country. The market factor is the return on the total universe of the different investment regions according to Worldscope. The excess return is calculated by subtracting the local one-month interbank rate. SMB is calculated by subtracting the top 80% of market capitalization from the bottom 20% of market capitalization. HML is constructed by subtracting the bottom 30% of book-to-market ration from the top 30%. MOM is calculated by subtracting the prior month bottom 30% performing stocks from the top 30% performing stocks. Returns and standard deviations are stated as monthly. Time periods coincide with the respective time periods used in the time-series analysis. Panel (A) through (E) report statistics referring to France, Germany, Italy, Spain and the UK, respectively. Table 5.2 Summary Statistics for Benchmark Portfolios European Funds France Europe Monthly Cross-Correlations Factor Excess Std t-stat for Portfolio Return Dev Mean = 0 Market SMB HML MOM Market 0,73% 4,78% 1,68 1,00 SMB 0,20% 2,15% 1,00 -0,30 1,00 HML 0,52% 3,50% 1,64 -0,09 0,06 1,00 MOM 0,11% 5,23% 0,24 -0,11 0,21 -0,58 1,00 01.1996 - 12.2005 / 120 Observations Germany Europe Monthly Cross-Correlations Factor Excess Std t-stat for Portfolio Return Dev Mean = 0 Market SMB HML MOM Market 0,74% 4,79% 1,69 1,00 SMB 0,20% 2,15% 1,00 -0,30 1,00 HML 0,52% 3,50% 1,64 -0,09 0,06 1,00 MOM 0,11% 5,23% 0,24 -0,11 0,21 -0,58 1,00 01.1996 - 12.2005 / 120 Observations Italy Europe Monthly Factor Excess Std t-stat for Cross-Correlations Portfolio Return Dev Mean = 0 Market SMB HML MOM Market 0,65% 4,76% 1,49 1,00 SMB 0,20% 2,15% 1,00 -0,30 1,00 HML 0,52% 3,50% 1,64 -0,08 0,06 1,00 MOM 0,11% 5,23% 0,24 -0,11 0,21 -0,58 1,00 01.1996 - 12.2005 / 120 Observations
30

Table 5.2 Continued Spain Europe Monthly Cross-Correlations Factor Excess Std t-stat for Portfolio Return Dev Mean = 0 Market SMB HML MOM Market 0,57% 4,93% 1,20 1,00 SMB 0,20% 2,15% 1,00 -0,29 1,00 HML 0,52% 3,50% 1,64 -0,08 0,06 1,00 MOM 0,11% 5,23% 0,24 -0,11 0,22 -0,57 1,00 01.1997 - 12.2005 / 108 Observations UK Europe Monthly Factor Excess Std t-stat for Cross-Correlations Portfolio Return Dev Mean = 0 Market SMB HML MOM Market 0,25% 4,89% 0,50 1,00 SMB 0,36% 2,10% 1,68 -0,20 1,00 HML 0,66% 3,86% 1,67 -0,07 0,03 1,00 MOM 0,05% 5,78% 0,09 -0,15 0,27 -0,58 1,00 01.1998 - 12.2005 / 98 Observations Summary statistics for loadings of the four fund portfolios sorted on different factors and separated by country. The market factor is the return on the total universe of the different investment regions according to Worldscope. The excess return is calculated by subtracting the local one-month interbank rate. SMB is calculated by subtracting the top 80% of market capitalization from the bottom 20% of market capitalization. HML is constructed by subtracting the bottom 30% of book-to-market ration from the top 30%. MOM is calculated by subtracting the prior month bottom 30% performing stocks from the top 30% performing stocks. Returns and standard deviations are stated as monthly. Time periods coincide with the respective time periods used in the time-series analysis. Panel (A) through (E) report statistics referring to France, Germany, Italy, Spain and the UK, respectively. Table 5.3 Summary Statistics for Benchmark Portfolios Global Funds France Global Monthly Cross-Correlations Factor Excess Std t-stat for Portfolio Return Dev Mean = 0 Market SMB HML MOM Market 0,35% 4,64% 0,87 1,00 SMB -0,19% 2,29% -0,95 0,01 1,00 HML 0,24% 4,45% 0,63 -0,17 0,51 1,00 MOM 0,23% 4,90% 0,54 0,00 -0,04 -0,56 1,00 01.1995 - 12.2005 / 132 Observations Germany Global Monthly Cross-Correlations Factor Excess Std t-stat for Portfolio Return Dev Mean = 0 Market SMB HML MOM Market 0,37% 4,65% 0,92 1,00 SMB -0,19% 2,29% -0,95 0,01 1,00 HML 0,24% 4,45% 0,63 -0,17 0,51 1,00 MOM 0,23% 4,90% 0,54 0,00 -0,04 -0,56 1,00 01.1995 - 12.2005 / 132 Observations
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Table 5.3 Continued Italy Global Monthly Cross-Correlations Factor Excess Std t-stat for Portfolio Return Dev Mean = 0 Market SMB HML MOM Market 0,25% 4,64% 0,61 1,00 SMB -0,19% 2,29% -0,95 0,02 1,00 HML 0,24% 4,45% 0,63 -0,16 0,51 1,00 MOM 0,23% 4,90% 0,54 0,00 -0,04 -0,56 1,00 01.1995 - 12.2005 / 132 Observations Spain Global Monthly Cross-Correlations Factor Excess Std t-stat for Portfolio Return Dev Mean = 0 Market SMB HML MOM Market 0,25% 4,80% 0,58 1,00 SMB -0,26% 2,33% -1,22 0,02 1,00 HML 0,23% 4,64% 0,54 -0,16 0,50 1,00 MOM 0,30% 5,09% 0,64 -0,01 -0,03 -0,57 1,00 01.1996 - 12.2005 / 120 Observations UK Global Monthly Cross-Correlations Factor Excess Std t-stat for Portfolio Return Dev Mean = 0 Market SMB HML MOM Market 0,20% 4,95% 0,39 1,00 SMB 0,04% 2,15% 0,19 0,06 1,00 HML -0,14% 4,99% -0,27 0,11 -0,03 1,00 MOM 0,21% 5,60% 0,37 -0,09 -0,10 -0,60 1,00 01.1998 - 12.2005 / 96 Observations Summary statistics for loadings of the four fund portfolios sorted on different factors and separated by country. The market factor is the return on the total universe of the different investment regions according to Worldscope. The excess return is calculated by subtracting the local one-month interbank rate. SMB is calculated by subtracting the top 80% of market capitalization from the bottom 20% of market capitalization. HML is constructed by subtracting the bottom 30% of book-tomarket ration from the top 30%. MOM is calculated by subtracting the prior month bottom 30% performing stocks from the top 30% performing stocks. Returns and standard deviations are stated as monthly. Time periods coincide with the respective time periods used in the time-series analysis.
5.2 Performance Measurement

This study makes use of three performance models. The model used most often throughout the history of mutual fund research is the CAPM based single index model introduced by Sharpe (1964). The return component not captured by , the models only risk factor, is captured by the intercept. When analyzing the performance of mutual funds, the intercept stands for the return component not attributable to risk. It is therefore interpreted as a measure for the out- or underperformance of a fund relative to the market. If it is positive, the out-performance of the market is often attributed to the stock-picking talent of the funds manager based upon superior information. The corresponding regression is estimated as follows: Rit Rft = i + i(Rmt Rft) + it
32
Mutual Fund Performance in Europe The Role of Fund Size where Rit is the return of fund i in month t, Rft is the return on the one-month interbank rate in month t, Rmt is the return on an equity benchmark of the funds investment focus and it is an error term. However, this single-factor model accounts only for risk relative to the market. In the equity mutual fund sample used, several funds stick to a specific investment style. Some funds are confined to invest only in small cap stocks, in large cap stocks, in value stocks, in growth stocks or in a combination of those. The single-factor model neglects these differences and is therefore augmented by the Fama and French (1993) three-factor model. Especially in Fama and French (1996), this model proves to successfully account for the cross-sectional variation in stock returns. Hence, it should be the preferable choice when estimating risk-adjusted equity mutual fund returns. The three-factor-model is estimated as follows: Rit Rft = i + 0i(Rmt Rft) + 1iSMBt + 2iHMLt + it Although the three-factor model reduces errors compared to a single-factor model. Carhart (1997) found that it fails to account for the cross-sectional variation in portfolio returns when sorted based on their past twelve month performance. This is why he augments the three-factor model with a fourth factor, the momentum factor denoted as MOM. On the one hand, this most comprehensive model can be interpreted as a model with three risk-factors plus momentum. On the other hand, the portfolio returns can be interpreted as premia on the factor mimicking portfolios rewarding the investor with extra return for a certain investment strategy. Proponents of this latter view are, among others, Chan and Lakonishok (2004). Regardless of the exact interpretation, the four-factor model is estimated as follows: Rit Rft = i + 0i(Rmt Rft) + 1iSMBt + 2iHMLt + 3iMOMt + it Premia for the various factor mimicking portfolios differ from market to market and are also different for the altered time periods used in this study. Due to the short time periods for domestically investing funds, the monthly excess market return is negative in countries such as France, Germany, or Italy. Returns on all other factors are positive except for MOM in Germany and Spain. For equity mutual funds investing with a global perspective, the return on SMB is negative in four out of five European countries. Only in the UK a positive premium for SMB is obtained. With respect to HML an inverse picture is observed. While the continental European funds investing globally receive a premium for HML mimicking investments, the premium on HML is negative for globally investing UK funds. 33
Mutual Fund Performance in Europe The Role of Fund Size This inverse relationship among UK and continental European funds might originate in the shorter time-period used for the UK funds. Nevertheless, premia on MOM are positive for globally investing funds throughout all five countries under investigation. The picture looks more consistent when considering premia on the four factors for investments with a European focus. All four factors premia are positive in all five inspected countries. However, it should be noted contrary to what Carhart (1997) found, neither of the premia is significantly different from zero as indicated by the t-values reported in tables 5.1 through 5.3. Additionally, multicolinearity might affect the estimated premia. Positive correlations between SMB and HML indicate that the value premium is lower for small stocks, while negative correlations between HML and MOM indicate that momentum might be more important for growth stocks. A test of the asset pricing models accuracy is out of this studys scope. Therefore, this study relies on Otten and Bams (2002) who find strong evidence for the four-factor model as opposed to the single-factor model.
5.3 Portfolio Formation

The merged database contains funds separated by their country of distribution. Furthermore, as presented in section four, information is given on the geographical investment focus of the fund. For portfolio formation, the different geographical focuses are grouped in three broader geographical focuses: Global, Europe and Domestic. This second split is important because of the benchmarks used to estimate risk-adjusted returns. As explained above, benchmarks are different for different geographical investment focuses. Therefore, the initial sample is split in 15 sub samples separated by country of distribution and geographical investment focus of the fund. In a next step, each of the 15 sub samples is divided in five equally sized quintiles. This means that size is defined as a relative measure. Instead of defining absolute breakpoints for size, each quintile contains exactly 20 per cent of the funds of each sub sample. Furthermore, size is defined as a non-stationary quantity. Thus, portfolios have to be rebalanced every year based on information on the funds net asset value. This information is available for every fund in the matched sample as of the beginning of each year. Portfolios are therefore formed each year based on the size information relating to the funds beginning of the year net asset value. While they are live, funds can move from one quintile to another. Hence, the resulting return series do not correspond to any fixed group of funds. They contain returns belonging to their respective size quintile at each point in time during the sample period. As a result of the sample split according to fund size, 75 34
Mutual Fund Performance in Europe The Role of Fund Size return series each belonging to a different country, geographical investment focus and size quintile are obtained. For technical reasons, all size quintiles have to contain a minimum number of funds. If there was no minimum requirement, the different geographical investment focuses within the broader defined categories Global, Europe and Domestic would distort the fit of the asset pricing models used to estimate risk-adjusted returns. This is particularly important with respect to the sample of globally investing equity mutual funds. While this sample contains funds denoted as having a global investment focus, it also contains funds denoted as investing in particular countries outside Europe such as Malaysia or India. Returns of these regional funds differ by a great deal from those returns obtained from investing in global equity mutual funds. As a consequence, portfolio returns containing a small number of funds are very sensitive to individual fund return movements. Therefore, size would not be the only criterion affecting different portfolio returns for different size portfolios. The minimum number of funds that have to be contained in the Global and European portfolios is therefore 20, while the minimum number of funds for the domestic portfolio is 15. In addition to the return series corresponding to the fund quintiles sorted according to size, risk adjusted returns for the so-called spread portfolio are estimated. Returns on this portfolio are estimated by subtracting the returns obtained from investing in each years 20 per cent smallest funds from the returns obtained from investing in each years 20 per cent largest funds. The spread portfolio therefore mimics a long position in the large fund quintile and a short position in the small fund quintile.
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6 Time Series Analysis

Following the methodology laid down in the preceding chapter, this study continues to investigate the effect of equity mutual fund size on fund performance. Within the framework of a time series regression, most emphasis is put on the so-called Jensens (1968) alpha. It is a measurement for the fund managers ability to generate abnormal returns in excess of the risk-free rate. In addition to the normal CAPM based performance attribution model introduced by Sharpe (1964), this study considers the threefactor model of Fama and French (1993) as well as the four-factor model by Carhart (1997).
6.1 The effect of fund size in France

Restrictions for a minimum of 15 equity mutual funds per size quintile limit the sample period for domestically investing French funds to a period ranging from the year 2001 to 2004. Table 6.1 exhibits raw returns and standard deviations for the five size quintile portfolios as well as for a spread portfolio. Additionally, table 6.1 displays results obtained from estimating the three model specifications on the matched sample as described in the previous chapter. Adjusted R2, the coefficient of determination, is an indicator relating to the quality of the estimated linear model. It is generally higher for the three-factor model than for the one-factor model and higher for the four-factor model than for the three-factor model. However, the one-factor models fit is much better for portfolios containing large funds than for the ones containing smaller funds, especially portfolio one. This effect is due to portfolios one to four loading significantly on SMB, while this factor does not significantly add explanatory power to the estimation of portfolio five returns. While all five size portfolios have a negative exposure to the momentum (MOM) factor, none of the coefficients is significantly different from zero as indicated by the corresponding t-values below the coefficients. This is also why the three-factor models fit is almost as good as that of the four factor model. Throughout all model specifications, market beta decreases with the size of the funds contained in the portfolios. Referring to the four-factor model, market betas range from 0,94 for portfolio one to 1,18 for portfolio five. This is an indication for smaller funds taking considerably more market risk than larger funds. The performance measure alpha is significantly negative for all five portfolios. This means that all of the size portfolios under-perform the market on a net return basis. While 36
Mutual Fund Performance in Europe The Role of Fund Size the smaller portfolios out-performance is more pronounced than that of the larger ones, the spread portfolios alpha is positive but insignificant throughout all specifications.
Table 6.1 Portfolio Returns France Domestic
Panel A: Single-Factor Model
Portfolio 5 (large) 4 3 2 1 (small) 5-1 Spread
Monthly Excess Return -0,97% -0,87% -0,88% -0,94% -1,31% 0,34%
Std Dev 5,71% 5,80% 5,89% 6,16% 7,26% 2,78%
Alpha -0,36% (-2,23) -0,25% (-1,30) -0,26% (-1,51) -0,29% (-1,27) -0,59% (-1,37) 0,23% (0,61)
Market 0,97 (34,63) 0,98 (28,76) 1,00 (33,79) 1,03 (25,57) 1,15 (15,29) -0,18 (-2,72)
Adj R-Squared 0,96 0,95 0,96 0,93 0,83 0,12
Panel B: Three-Factor Model
Alpha -0,50% (-3,22) -0,56% (-4,96) -0,51% (-4,59) -0,63% (-3,67) -1,09% (-3,13) 0,59% (1,87)
Market 0,96 (31,43) 1,03 (46,17) 1,04 (47,84) 1,07 (31,88) 1,26 (18,55) -0,30 (-4,92)
SMB 0,10 (1,64) 0,41 (9,43) 0,34 (7,95) 0,40 (6,02) 0,75 (5,61) -0,65 (-5,40)
HML 0,09 (2,17) 0,05 (1,62) 0,04 (1,29) 0,09 (1,95) 0,01 (0,15) 0,07 (0,91)
Adj R-Squared 0,97 0,98 0,98 0,97 0,90 0,45
Panel C: Four-Factor Model
Adj Alpha Market SMB HML MOM R-Squared -0,51% 0,94 0,11 0,07 -0,04 0,97 (-3,25) (25,12) (1,86) (1,73) (-1,09) 4 -0,57% 1,02 0,42 0,04 -0,01 0,98 (-4,93) (37,13) (9,21) (1,36) (-0,53) 3 -0,52% 1,01 0,36 0,02 -0,04 0,99 (-4,77) (39,17) (8,40) (0,66) (-1,91) 2 -0,63% 1,06 0,40 0,08 -0,02 0,97 (-3,65) (25,55) (5,92) (1,68) (-0,50) 1 (small) -1,11% 1,18 0,80 -0,04 -0,13 0,91 (-3,26) (14,51) (6,02) (-0,42) (-1,81) 5-1 Spread 0,60% -0,24 -0,69 0,11 0,09 0,46 (1,93) (-3,24) (-5,64) (1,32) (1,43) Reported are loadings of the five value weighted NAV sorted portfolios on various factors. The factors are constructed as explained in section 5.1. Panel (A) reports loadings using the one-factor model. Panel (B) reports loadings using the three-factor model. Panel (C) reports loadings using the four-factor model. All alphas are reported on a monthly basis. The spread portfolios are built by subtracting the returns on the portfolio containing the smallest funds (portfolio 1) from the portfolio containing the largest funds (portfolio 5). T-values in parentheses. Portfolio 5 (large)
37
Mutual Fund Performance in Europe The Role of Fund Size As with domestically investing equity mutual funds, restrictions for a minimum number of funds per size quintile limit the sample period for French funds investing with a Europe wide focus to a period ranging from 1996 to 2005.
Table 6.1 France Europe
Monthly Excess Return 0,67% 0,62% 0,59% 0,46% 0,42% 0,24%
Std Dev 5,32% 5,10% 5,25% 5,11% 5,28% 1,31%
Alpha -0,13% (-1,39) -0,15% (-1,83) -0,20% (-1,90) -0,31% (-3,12) -0,36% (-2,66) 0,22% (1,84)
Market 1,10 (55,03) 1,05 (62,82) 1,08 (50,23) 1,05 (50,52) 1,07 (38,38) 0,03 (1,12)
Adj R-Squared 0,96 0,97 0,95 0,96 0,93 0,00
Alpha -0,11% (-1,21) -0,19% (-2,53) -0,19% (-2,26) -0,36% (-3,69) -0,43% (-3,38) 0,32% (2,69)
Market 1,10 (56,01) 1,08 (68,38) 1,10 (61,31) 1,07 (51,13) 1,10 (40,78) 0,00 (-0,01)
SMB 0,10 (2,32) 0,19 (5,48) 0,24 (6,13) 0,16 (3,47) 0,28 (4,64) -0,18 (-3,18)
HML -0,09 (-3,50) -0,03 (-1,50) -0,14 (-5,88) 0,00 (0,18) -0,02 (-0,52) -0,07 (-2,19)
Adj R-Squared 0,97 0,98 0,97 0,96 0,94 0,10
Adj Alpha Market SMB HML MOM R-Squared -0,13% 1,11 0,09 -0,07 0,03 0,97 (-1,36) (55,85) (1,94) (-2,05) (1,19) 4 -0,19% 1,08 0,19 -0,03 0,00 0,98 (-2,51) (67,61) (5,26) (-1,14) (0,07) 3 -0,18% 1,10 0,25 -0,15 -0,02 0,97 (-2,12) (60,71) (6,15) (-5,20) (-0,89) 2 -0,36% 1,07 0,16 0,01 0,00 0,96 (-3,65) (50,54) (3,34) (0,15) (0,01) 1 (small) -0,40% 1,10 0,31 -0,07 -0,05 0,94 (-3,15) (40,66) (4,99) (-1,50) (-1,78) 5-1 Spread 0,27% 0,01 -0,22 0,00 0,08 0,16 (2,36) (0,34) (-3,92) (-0,01) (2,92) Reported are loadings of the five value weighted NAV sorted portfolios on various factors. The factors are constructed as explained in section 5.1. Panel (A) reports loadings using the one-factor model. Panel (B) reports loadings using the three-factor model. Panel (C) reports loadings using the four-factor model. All alphas are reported on a monthly basis. The spread portfolios are built by subtracting the returns on the portfolio containing the smallest funds (portfolio 1) from the portfolio containing the largest funds (portfolio 5). T-values in parentheses. Portfolio 5 (large)
38
Mutual Fund Performance in Europe The Role of Fund Size Generally, table 6.2 as well as all other tables in section 6.1 through 6.5 display the same properties and model specifications as table 6.1 described in the previous section. The model fit as indicated by the adjusted R2 is not much different for the various model specifications. As in the case of domestically investing funds, smaller quintiles load more extensively on SMB than larger ones. This results in a negative and significant exposure to SMB for the spread portfolio. No clear pattern for the portfolios exposures to HML and MOM is observed. Some load positively on these factors while others have a negative exposure. Nevertheless, referring to the four-factor model estimation, MOM adds explanatory power to the estimation of the spread portfolio which loads negatively and significantly on MOM. Unlike in the previous section, where smaller portfolios were observed to take more risk than larger ones, no clear pattern for market beta is detected. All market betas are larger than one and very similar to each other. This is why the singlefactor model is unable to explain the spread portfolios return series as indicated by an adjusted R2 of 0,00. However, different portfolio exposures to SMB and HML help raise the spread portfolios model fit when estimated with the three- and four factor model. Alphas for the size quintile portfolios are generally negative throughout all portfolios. While the largest fund quintiles under-performance is statistically indistinguishable from 0 as indicated by a t-value of -1,36, the smallest fund quintile significantly under-performs the market on a risk-adjusted basis estimated with the fourfactor model. The probability of this latter result being attributable to chance is merely 0,2 per cent. The difference between the returns obtained from investing in the portfolio containing large funds and the returns obtained from investing in the portfolio containing small funds as represented by the spread portfolio is positive on average. The spread portfolios alpha is positive (0,27 per cent) and significantly different from zero at the five per cent level. Table 6.3 displays results for equity mutual funds investing with a global scope. By looking at the adjusted R2s it can be seen that the single-factor model lacks explanatory power. This is indicated by a model fit of 0,73 for portfolio 1. Overall, larger portfolios are estimated substantially better than smaller ones. Even the three-and four-factor models are unable to explain much of the returns obtained from investing in portfolio one. All portfolios load negatively and significantly on SMB, indicating that regardless of fund size, French worldwide investing equity mutual funds seem to prefer investments in larger companies. While large funds seem to prefer investing in growth stocks as indicated by an exposure of -0,14 to HML for portfolio 5 when estimated with the four-factor model, other 39
Mutual Fund Performance in Europe The Role of Fund Size fund quintiles do not reveal a preference for either growth or value investing. Although all five portfolios load positively on MOM, neither of the loadings is significantly different from zero. This is also why the adjusted R2 is better for none of the portfolios when estimated with the four-factor model as compared to the three-factor model. Interestingly, with respect to market beta, the exact opposite results as for domestically investing equity mutual funds are obtained. Market beta is smallest for portfolio one and highest for portfolio five. Hence, funds with less net asset volume take less market risk than funds with more net asset volume. Alphas are generally negative for all portfolios investigated. Although portfolio five significantly under-performs the market, the spread portfolios under-performance is insignificant due the overall inferior performance of any size portfolio.
Table 6.3 Portfolio Returns France Global
Monthly Excess Return 0,06% 0,10% 0,25% 0,17% 0,12% -0,07%
Std Dev 5,69% 5,49% 5,31% 5,21% 5,07% 1,87%
Alpha -0,33% (-1,43) -0,27% (-1,17) -0,11% (-0,49) -0,17% (-0,77) -0,21% (-0,89) -0,12% (-0,80)
Market 1,09 (22,15) 1,04 (21,07) 1,01 (20,83) 0,98 (20,24) 0,94 (18,77) 0,16 (4,83)
Adj R-Squared 0,79 0,77 0,77 0,76 0,73 0,15
Alpha -0,34% (-1,85) -0,34% (-1,75) -0,19% (-0,94) -0,26% (-1,30) -0,30% (-1,36) -0,04% (-0,33)
Market 1,06 (26,58) 1,03 (24,66) 1,00 (23,17) 0,98 (22,28) 0,94 (19,87) 0,12 (4,27)
SMB -0,40 (-4,31) -0,52 (-5,4) -0,49 (-4,90) -0,51 (-4,97) -0,46 (-4,15) 0,06 (0,86)
HML -0,21 (-4,42) -0,11 (-2,19) -0,06 (-1,07) -0,02 (-0,35) 0,01 (0,18) -0,22 (-6,53)
Adj R-Squared 0,87 0,84 0,82 0,81 0,77 0,38
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Table 6.3. Continued
Adj Alpha Market SMB HML MOM R-Squared -0,39% 1,07 -0,47 -0,14 0,09 0,87 (-2,14) (26,76) (-4,72) (-2,2) (1,84) 4 -0,36% 1,03 -0,55 -0,08 0,04 0,84 (-1,84) (24,39) (-5,28) (-1,23) (0,70) 3 -0,21% 1,01 -0,52 -0,02 0,04 0,82 (-1,04) (22,94) (-4,83) (-0,35) (0,74) 2 -0,28% 0,99 -0,53 0,01 0,03 0,81 (-1,37) (22,01) (-4,82) (0,09) (0,55) 1 (small) -0,32% 0,95 -0,49 0,04 0,04 0,76 (-1,46) (19,68) (-4,12) (0,59) (0,72) 5-1 Spread -0,07% 0,13 0,02 -0,19 0,05 0,39 (-0,55) (4,45) (0,31) (-4,15) (1,38) Reported are loadings of the five value weighted NAV sorted portfolios on various factors. The factors are constructed as explained in section 5.1. Panel (A) reports loadings using the one-factor model. Panel (B) reports loadings using the three-factor model. Panel (C) reports loadings using the four-factor model. All alphas are reported on a monthly basis. The spread portfolios are built by subtracting the returns on the portfolio containing the smallest funds (portfolio 1) from the portfolio containing the largest funds (portfolio 5). T-values in parentheses. Portfolio 5 (large)
6.2 The effect of fund size in Germany

Results obtained from estimating risk-adjusted returns of German equity mutual funds with a domestic investment scope are exhibited in table 6.4. The adjusted R2s displayed in the column on the right indicate that either model fits the data well. When estimating the return data with the four-factor model, it can be seen that German domestically investing funds load negatively and significantly on MOM. Introducing the MOM factor takes away much of the explanatory power of HML. While all portfolios load positively and mostly significantly on HML when estimated with the three-factor model, MOM is insignificant in the four-factor model estimation. Cross-correlations displayed in chapter four reveal that HML and MOM are correlated with -0,71 for the period 2001 to 2004. Therefore, the two factors are to some extent interchangeable. With an R2 of 0,60 the spread portfolio is quite well estimated with all of the independent variables being significant at the five per cent level. The portfolios significant and negative exposure to market beta again indicates that smaller domestically investing funds seem to prefer a higher market risk than larger ones. Alphas are significantly negative for all five size portfolios. Even though the spread portfolios alpha is positive, it is statistically indistinguishable from zero. Furthermore, there is no clear pattern in the magnitude of alpha among the five size portfolios.
41

Table 6.4 Portfolio Returns Germany Domestic
Std Dev 7,16% 7,10% 6,95% 6,51% 6,92% 1,31%
Alpha -0,42% (-1,83) -0,42% (-2,15) -0,41% (-1,95) -0,27% (-1,41) -0,57% (-2,35) 0,15% (0,96)
Market 1,15 (30,01) 1,15 (34,92) 1,12 (31,86) 1,05 (33,54) 1,10 (27,42) 0,05 (1,78)
Adj R-Squared 0,93 0,94 0,93 0,94 0,91 0,03
Alpha -0,58% (-2,80) -0,52% (-2,66) -0,47% (-2,43) -0,39% (-2,26) -0,70% (-3,29) 0,13% (1,20)
Market 1,18 (20,51) 1,22 (22,47) 1,30 (23,77) 1,20 (25,14) 1,31 (21,21) -0,12 -(4,18)
SMB 0,03 (0,36) 0,11 (1,46) 0,31 (4,07) 0,25 (3,70) 0,34 (3,96) -0,32 (-7,55)
HML 0,16 (4,54) 0,08 (2,54) 0,04 (1,11) 0,10 (3,48) 0,11 (2,97) 0,05 (2,68)
Adj R-Squared 0,94 0,95 0,95 0,95 0,93 0,56
Alpha Market SMB HML MOM -0,53% 1,13 0,00 0,07 -0,08 (-2,66) (18,83) (0,01) (1,36) (-2,27) 4 -0,46% 1,16 0,08 -0,03 -0,10 0,95 (-2,51) (21,03) (1,04) (-0,55) (-3,06) 3 -0,44% 1,25 0,29 -0,04 -0,07 0,95 (-2,28) (21,88) (3,79) (-0,82) (-2,07) 2 -0,35% 1,16 0,22 0,02 -0,07 0,96 (-2,09) (23,35) (3,40) (0,49) (-2,49) 1 (small) -0,64% 1,23 0,30 -0,02 -0,12 0,94 (-3,09) (19,87) (3,66) (-0,36) (-3,23) 5-1 Spread 0,11% -0,10 -0,30 0,09 0,04 0,60 (1,03) (-3,23) (-7,30) (3,35) (2,06) Reported are loadings of the five value weighted NAV sorted portfolios on various factors. The factors are constructed as explained in section 5.1. Panel (A) reports loadings using the one-factor model. Panel (B) reports loadings using the three-factor model. Panel (C) reports loadings using the four-factor model. All alphas are reported on a monthly basis. The spread portfolios are built by subtracting the returns on the portfolio containing the smallest funds (portfolio 1) from the portfolio containing the largest funds (portfolio 5). T-values in parentheses.
Portfolio 5 (large)
Adj R-Squared 0,95
Table 6.5 displays results relating to funds investing in Europe. Despite the larger heterogeneity among funds investing with a European investment focus, the model fit is 42
Mutual Fund Performance in Europe The Role of Fund Size better as that of domestically investing funds. All portfolios except portfolio five load positively and significantly on SMB, while all funds load negatively on HML. This reveals a preference for small growth stocks for the average fund in the portfolios. Apart from portfolio 1, which seems to prefer contrarian investment, none of the portfolios loads significantly on MOM. Market betas lie above one regardless of the portfolio investigated and the model estimated. A pattern in market betas comparable to that found for domestically investing funds can not be detected. None of the portfolios has a market beta exposure differing by a great deal from others. All alphas are negative while portfolio one reveals the best performance. Its alpha is statistically indistinguishable from zero. All other portfolios significantly under-perform the market. This also counts for the spread portfolio with a positive but insignificant alpha.
Table 6.5 Portfolio Returns Germany Europe
Std Dev 5,52% 5,21% 5,25% 4,96% 5,27% 1,35%
Alpha -0,26% (-2,27) -0,17% (-1,88) -0,26% (-2,94) -0,27% (-2,49) -0,30% (-2,85) 0,05% (0,40)
Market 1,13 (48,40) 1,07 (57,20) 1,08 (60,18) 1,01 (44,36) 1,08 (48,75) 0,05 (2,01)
Adj R-Squared 0,95 0,96 0,97 0,94 0,95 0,02
Alpha -0,18% (-1,72) -0,18% (-2,20) -0,26% (-3,11) -0,27% (-2,50) -0,34% (-3,35) 0,16% (1,31)
Market 1,13 (49,69) 1,09 (64,24) 1,10 (62,46) 1,02 (43,88) 1,11 (51,42) 0,02 (0,82)
SMB 0,02 (0,49) 0,20 (5,16) 0,14 (3,51) 0,12 (2,25) 0,21 (4,43) -0,19 (-3,34)
HML -0,14 (-4,77) -0,09 (-4,13) -0,07 (-3,05) -0,06 (-1,96) -0,05 (-1,84) -0,09 (-2,71)
Adj R-Squared 0,96 0,97 0,97 0,95 0,96 0,15
43

Table 6.5 Continued
Adj Alpha Market SMB HML MOM R-Squared -0,20% 1,13 0,01 -0,12 0,02 0,96 (-1,83) (49,44) (0,22) (-3,19) (0,97) 4 -0,18% 1,09 0,19 -0,09 0,00 0,97 (-2,20) (63,54) (4,92) (-3,14) (0,19) 3 -0,26% 1,10 0,13 -0,06 0,01 0,97 (-3,12) (61,83) (3,28) (-2,17) (0,38) 2 -0,28% 1,02 0,11 -0,05 0,01 0,95 (-2,50) (43,41) (2,11) (-1,41) (0,22) 1 (small) -0,31% 1,10 0,24 -0,10 -0,06 0,96 (-3,07) (51,81) (4,99) (-2,96) (-2,41) 5-1 Spread 0,11% 0,03 -0,23 -0,02 0,08 0,20 (0,95) (1,20) (-4,10) (-0,40) (2,98) Reported are loadings of the five value weighted NAV sorted portfolios on various factors. The factors are constructed as explained in section 5.1. Panel (A) reports loadings using the one-factor model. Panel (B) reports loadings using the three-factor model. Panel (C) reports loadings using the four-factor model. All alphas are reported on a monthly basis. The spread portfolios are built by subtracting the returns on the portfolio containing the smallest funds (portfolio 1) from the portfolio containing the largest funds (portfolio 5). T-values in parentheses. Portfolio 5 (large)
Analogous to what is observed for French equity mutual funds, the one-factor models lack of accuracy is most pronounced for globally investing funds as exhibited in table6.6. While the one-factor models adjusted R2 is lower than 0,80 regardless of the portfolio examined, the three- and four-factor models fit improves with the size quintiles in an ascending order. This is because portfolios containing larger funds load more heavily on additional factors than other portfolios. As all portfolios display a significant and negative exposure to SMB, only portfolio five significantly loads on HML. This indicates that large funds on average choose to invest in large growth stocks. Moreover, none of the five portfolios has a significant exposure to MOM. Portfolio one has a somewhat higher market beta than portfolio five as it is also signified by the spread portfolios positive market beta which is significant at the ten per cent level. All portfolios under-perform the market, although portfolio fives underperformance is insignificant. With a t-value of 1,10 the spread portfolios alpha is insignificantly different from zero, as well. Interestingly, the single-factor model fails to acknowledge the significant underperformance of portfolios one through four due to the negligence of additional (risk) factors.
44

Table 6.6 Portfolio Returns Germany Global
Std Dev 5,50% 5,35% 5,18% 5,31% 5,08% 1,71%
Alpha -0,21% (-0,92) -0,29% (-1,34) -0,27% (-1,26) -0,33% (-1,51) -0,31% (-1,48) 0,10% (0,65)
Market 1,04 (20,84) 1,03 (22,06) 0,99 (21,22) 1,02 (21,92) 0,97 (21,42) 0,07 (23,05)
Adj R-Squared 0,77 0,79 0,77 0,79 0,78 0,03
Alpha -0,23% (-1,44) -0,35% (-2,07) -0,36% (-2,06) -0,41% (-2,25) -0,40% (-2,15) 0,17% (1,44)
Market 1,00 (29,28) 1,01 (27,16) 0,98 (25,76) 1,01 (25,71) 0,97 (24,06) 0,03 (1,33)
SMB -0,49 (-6,12) -0,53 (-6,12) -0,57 (-6,48) -0,53 (-5,80) -0,50 (-5,36) 0,01 (0,25)
HML -0,26 (-6,35) -0,12 (-2,68) -0,07 (-1,57) -0,07 (-1,52) -0,02 (-0,50) -0,24 (-7,62)
Adj R-Squared 0,90 0,87 0,86 0,85 0,83 0,39
Alpha Market SMB HML MOM -0,25% 1,01 -0,52 -0,23 0,04 (-1,59) (29,06) (-6,08) (-4,22) (1,03) 4 -0,38% 1,02 -0,56 -0,08 0,04 0,87 (-2,19) (26,94) (-6,05) (-1,44) (0,95) 3 -0,38% 0,98 -0,59 -0,05 0,03 0,85 (-2,13) (25,45) (-6,26) (-0,80) (0,63) 2 -0,39% 1,01 -0,51 -0,10 -0,03 0,85 (-2,11) (25,19) (-5,18) (-1,56) (-0,61) 1 (small) -0,38% 0,96 -0,48 -0,04 -0,02 0,83 (-2,05) (23,58) (-4,82) (-0,67) (-0,46) 5-1 Spread 0,13% 0,04 -0,03 -0,19 0,07 0,40 (1,10) (1,68) (-0,52) (-4,58) (2,11) Reported are loadings of the five value weighted NAV sorted portfolios on various factors. The factors are constructed as explained in section 5.1. Panel (A) reports loadings using the one-factor model. Panel (B) reports loadings using the three-factor model. Panel (C) reports loadings using the four-factor model. All alphas are reported on a monthly basis. The spread portfolios are built by subtracting the returns on the portfolio containing the smallest funds (portfolio 1) from the portfolio containing the largest funds (portfolio 5). T-values in parentheses.
Portfolio 5 (large)
Adj R-Squared 0,90
45
6.3 The effect of fund size in Italy

Table 6.7 reports results relating to Italian equity mutual funds investing in domestic stocks. All size portfolios are almost equally well estimated with the single-factor model as with the three- and four factor models. This is because style specific adjustments such as SMB and HML only play a minor role in explaining risk-adjusted returns for most portfolios. After all, fund return srae very well estimated by merely using the one-factor model. Italian mutual fund managers do not seem to Nevertheless, a clear trend with respect to SMB is detected. With reference to the three- and four-factor models, the portfolios exposure to SMB increases as the net asset value of the funds decreases. Therefore, smaller funds seem to favour smaller stocks while larger funds prefer larger stocks. Market betas are quite small throughout all portfolios investigated. With reference to the four-factor model, market beta ranges from 0,74 to 0,85. Furthermore, the previous finding in France and Germany of larger market betas for domestically investing funds with less net asset value is confirmed for Italy. This results in a negative and significant market exposure for the spread portfolio. All five portfolios slightly under-perform the market with alphas ranging from -0,10 to -0,27. However, none of the alphas is significantly different from zero.
Table 6.7 Portfolio Returns Italy Domestic
Portfolio 5 4 3 2 1 5-1 Spread
Std Dev 5,29% 5,13% 5,01% 4,82% 4,88% 0,84%
Alpha -0,16% (-3,35) -0,08% (-1,20) -0,09% (-1,20) -0,02% (-0,20) -0,22% (-1,86) 0,06% (0,53)
Market 0,88 (102,86) 0,87 (70,76) 0,90 (68,22) 0,92 (45,91) 0,95 (44,56) -0,07 (-3,20)
Adj R-Squared 1,00 0,99 0,99 0,98 0,98 0,16
46

Table 6.7 Continued
Alpha -0,16% (-3,24) 0,00 (-1,09) -0,10% (-1,58) -0,04% (-0,43) -0,20% (-2,33) 0,04% (0,55)
Market 0,88 (96,73) 0,87 (69,43) 0,92 (78,28) 0,94 (61,89) 0,96 (59,40) -0,08 (-5,38)
SMB 0,00 (-0,01) 0,06 (1,87) 0,12 (3,99) 0,25 (6,11) 0,28 (6,46) -0,28 (-7,05)
HML 0,00 (0,00) -0,03 (-1,23) 0,00 (-0,04) -0,02 (-0,74) -0,08 -(2,85) 0,08 (3,12)
Adj R-Squared 1,00 0,99 0,99 0,99 0,99 0,59
Adj Alpha Market SMB HML MOM R-Squared -0,16% 0,88 0,00 0,00 -0,01 1,00 (-3,27) (78,12) (0,16) (0,13) (-0,77) 4 -0,08% 0,86 0,08 -0,02 -0,03 0,99 (-1,28) (57,51) (2,33) (-0,92) (-2,06) 3 -0,10% 0,92 0,12 0,00 0,00 0,99 (-1,56) (63,14) (3,86) (-0,04) (-0,02) 2 -0,03% 0,94 0,25 -0,02 0,00 0,99 (-0,42) (50,01) (5,88) (-0,74) (0,14) 1 -0,20% 0,97 0,27 -0,08 0,01 0,99 (-2,27) (48,40) (6,15) (-2,89) (0,56) 5-1 Spread 0,04% -0,09 -0,27 0,08 -0,02 0,59 (0,47) (-5,03) (-6,7) (3,26) (-1,09) Reported are loadings of the five value weighted NAV sorted portfolios on various factors. The factors are constructed as explained in section 5.1. Panel (A) reports loadings using the one-factor model. Panel (B) reports loadings using the three-factor model. Panel (C) reports loadings using the four-factor model. All alphas are reported on a monthly basis. The spread portfolios are built by subtracting the returns on the portfolio containing the smallest funds (portfolio 1) from the portfolio containing the largest funds (portfolio 5). T-values in parentheses. Portfolio 5
Table 6.7 exhibits results obtained from regressing the three model specifications on returns obtained from investing in portfolios containing Italian funds with a Europe wide investment focus. As in the case of domestically investing Italian funds, funds with fewer assets under management seem to invest in smaller companies than funds more assets under management. Regardless of the model specification, the portfolios exposure to SMB increases as size portfolios get smaller. Most portfolios load negatively on HML while MOM helps to explain returns obtained from investing in portfolios two and five. Both portfolios load positively on MOM. Market betas all range above one, regardless of the model specification. Moreover, there is no pattern in betas suggesting a no size dependent exposure to market risk. Smaller funds do on average perform worse than larger ones. Although the spread portfolios alpha is negative, it is statistically indistinguishable from zero as indicated by a t-value of 1,20. 47

Table 6.8 Portfolio Returns Italy European
Std Dev 5,20% 5,11% 4,99% 4,61% 5,04% 1,41%
Alpha -0,16% (-1,25) -0,08% (-0,62) -0,13% (-1,48) -0,21% (-2,40) -0,24% (-2,14) 0,09% (0,66)
Market 1,06 (40,65) 1,04 (39,72) 1,03 (55,05) 1,03 (56,06) 1,03 (43,43) 0,03 (1,10)
Adj R-Squared 0,93 0,93 0,96 0,96 0,94 0,00
Alpha -0,10% (-0,79) -0,05% (-0,41) -0,13% (-1,49) -0,24% (-2,82) -0,28% (-2,66) 0,19% (1,48)
Market 1,06 (40,97) 1,05 (42,56) 1,05 (57,21) 1,05 (58,49) 1,06 (46,72) 0,00 (-0,03)
SMB 0,05 (0,89) 0,18 (3,22) 0,13 (3,31) 0,17 (4,22) 0,24 (4,86) -0,19 (-3,22)
HML -0,13 (-3,98) -0,14 (-4,45) -0,08 (-3,27) -0,04 (-1,71) -0,05 (-1,83) -0,08 (-2,27)
Adj R-Squared 0,94 0,94 0,97 0,97 0,95 0,11
Adj Alpha Market SMB HML MOM R-Squared -0,13% 1,07 0,02 -0,08 0,07 0,94 (-1,10) (41,69) (0,29) (-1,81) (2,29) 4 -0,07% 1,06 0,16 -0,11 0,03 0,94 (-0,57) (42,51) (2,80) (-2,77) (1,25) 3 -0,14% 1,05 0,12 -0,05 0,03 0,97 (-1,65) (57,12) (2,88) (-1,81)) (1,29) 2 -0,26% 1,06 0,14 0,00 0,05 0,97 (-3,15) (59,42) (3,56) (0,03) (2,31) 1 (small) -0,28% 1,06 0,24 -0,05 0,00 0,95 (-2,63) (46,18) (4,67) (-1,44) (0,00) 5-1 Spread 0,15% 0,01 -0,23 -0,02 0,07 0,14 (1,20) (0,24) (-3,72) (-0,49) (2,19) Reported are loadings of the five value weighted NAV sorted portfolios on various factors. The factors are constructed as explained in section 5.1. Panel (A) reports loadings using the one-factor model. Panel (B) reports loadings using the three-factor model. Panel (C) reports loadings using the four-factor model. All alphas are reported on a monthly basis. The spread portfolios are built by subtracting the returns on the portfolio containing the smallest funds (portfolio 1) from the portfolio containing the largest funds (portfolio 5). T-values in parentheses. Portfolio 5 (large)
Results displayed in table 6.9 signify that the single-factor models fit is inferior to the three- and four-factor model for globally investing funds. All size portfolios load negatively and significantly on SMB, indicating a preference for investments in large cap 48
Mutual Fund Performance in Europe The Role of Fund Size stocks. Moreover, larger funds appear to favour growth stocks as indicated by portfolio fives negative loading on HML. None of the size portfolios loads significantly on MOM. Therefore the four-factor model has no more explanatory power than the three-factor model. Contrary to what is observed in France and Germany, market betas for Italian globally investing funds are not higher for larger funds. In fact, there is no trend in market betas suggesting no size dependence of exposure to market risk. Apart from portfolio three, all size portfolios significantly under-perform the market. With an alpha of -0,49 per cent, portfolio one performs worst.
Table 6.9 Portfolio Returns Italy Global Panel A: Single-Factor Model Monthly Excess Std Portfolio Return Dev 5 (large) -0,03% 4,99%
4 3 2 1 (small) 5-1 Spread -0,06% 0,01% -0,13% -0,17% 0,14% 4,90% 5,20% 5,19% 5,13% 1,52%
Alpha -0,27% (-1,31) -0,29% (-1,52) -0,23% (-1,04) -0,38% (-1,79) -0,41% (-1,84) 0,14% (1,04)
Market 0,96 (21,67) 0,95 (22,58) 0,98 (20,58) 0,99 (21,73) 0,97 (20,22) -0,01 (-0,34)
Adj R-Squared 0,78 0,80 0,76 0,78 0,76 -0,01

Portfolio 5 (large) 4 3 2 1 (small) 5-1 Spread Alpha -0,31% (-2,20) -0,36% (-2,47) -0,29% (-1,68) -0,46% (-2,54) -0,49% (-2,43) 0,18% (1,47) Market 0,93 (30,33) 0,93 (29,63) 0,97 (25,57) 0,99 (24,97) 0,97 (22,03) -0,03 (-1,28) SMB -0,50 (-6,97) -0,51 (-6,93) -0,53 (-6,00) -0,51 (-5,57) -0,46 (-4,56) -0,03 (-0,53) HML -0,19 (-5,05) -0,12 (-3,25) -0,14 (-3,07) -0,05 (-1,02) -0,03 (-0,61) -0,16 (-4,91) Adj R-Squared 0,90 0,89 0,86 0,84 0,80 0,21
49

Table 6.9 Continued Panel C: Four-Factor Model
Adj Alpha Market SMB HML MOM R-Squared -0,32% 0,93 -0,50 -0,18 0,01 0,90 (-2,21) (29,84) (-6,57) (-3,79) (0,26) 4 -0,40% 0,94 -0,55 -0,07 0,06 0,89 (-2,72) (29,70) (-7,11) (-1,44) (1,68) 3 -0,32% 0,97 -0,56 -0,10 0,05 0,86 (-1,83) (25,42) (-6,00) (-1,65) (1,11) 2 -0,48% 0,99 -0,53 -0,03 0,02 0,84 (-2,56) (24,63) (-5,35) (-0,48) (0,47) 1 (small) -0,48% 0,96 -0,45 -0,05 -0,02 0,80 (-2,34) (21,60) (-4,13) (-0,66) (-0,31) 5-1 Spread 0,16% -0,03 -0,05 -0,13 0,03 0,21 (1,32) (-1,12) (-0,79) (-3,24) (0,82) Reported are loadings of the five value weighted NAV sorted portfolios on various factors. The factors are constructed as explained in section 5.1. Panel (A) reports loadings using the one-factor model. Panel (B) reports loadings using the three-factor model. Panel (C) reports loadings using the four-factor model. All alphas are reported on a monthly basis. The spread portfolios are built by subtracting the returns on the portfolio containing the smallest funds (portfolio 1) from the portfolio containing the largest funds (portfolio 5). T-values in parentheses. Portfolio 5 (large)
6.4 The effect of fund size in Spain

As shown in table 6.10, the best of all model fits is obtained for Spanish domestically investing equity mutual funds. Adjusted R2s of 1,00 for portfolios three and five when estimated with the three- and four factor model indicate that the models almost completely explain returns acquired from investing in these portfolios. Whereas the SMB factor does not play a role in estimating risk-adjusted returns, all portfolios have a positive and significant exposure to HML. Hence, Spanish domestically investing funds seem to pursue a value strategy. Portfolios five and two load negatively on MOM, an effect that is absent for the other portfolios. In fact, most of the portfolio returns are captured by the singlefactor model signifying that Spanish funds do not take positions far away from the benchmark. Interestingly, smaller funds have no higher exposure to market risk than larger funds. This pattern is observed in France, Germany and Italy but not for Spain. Furthermore, smaller funds take significantly less market risk than larger ones. This is testified by the spread portfolios positive and significant exposure to the market. Regardless of the model specification, all five size portfolios significantly underperform the market on a risk-adjusted basis.
50

Table 6.10 Portfolio Returns Spain Domestic
Monthly Excess Return -0,22% -0,14% -0,18% -0,12% -0,15% -0,07%
Std Dev 6,21% 5,80% 5,65% 5,96% 4,96% 1,42%
Alpha -0,33% (-3,80) -0,24% (-3,03) -0,28% (-3,81) -0,22% (-2,25) -0,24% (-2,55) -0,09% (-0,95)
Market 1,13 (69,86) 1,05 (70,95) 1,03 (77,16) 1,08 (59,69) 0,90 (51,48) 0,23 (12,88)
Adj R-Squared 0,99 0,99 0,99 0,99 0,98 0,78
Alpha -0,35% (-5,02) -0,31% (-4,48) 0,00 (-5,51) -0,27% (-3,22) -0,35% (-3,69) 0,00% (0,03)
Market 1,14 (73,77) 1,08 (70,38) 1,04 (86,35) 1,11 (58,38) 0,94 (44,40) 0,20 (9,42)
SMB -0,05 (-1,82) 0,01 (0,36) -0,03 (-1,59) -0,01 (-0,40) 0,07 (1,90) -0,12 (-3,22)
HML 0,11 (6,74) 0,09 (5,47) 0,09 (7,48) 0,11 (5,49) 0,05 (2,35) 0,06 (2,56)
Adj R-Squared 1,00 0,99 1,00 0,99 0,99 0,82
Alpha Market SMB HML MOM -0,38% 1,12 -0,03 0,11 -0,04 (-5,66) (62,38) (-0,96) (7,22) (-2,37) 4 -0,32% 1,07 0,02 0,09 -0,02 0,99 (-4,56) (57,22) (0,66) (5,50) (-0,91) 3 -0,30% 1,04 -0,03 0,09 -0,01 1,00 (-5,42) (70,07) (-1,32) (7,43) (-0,44) 2 -0,32% 1,08 0,02 0,11 -0,05 0,99 (-3,86) (49,29) (0,47) (5,94) (-2,48) 1 -0,34% 0,94 0,06 0,05 0,01 0,99 (-3,49) (36,32) (1,64) (2,30) (0,34) 5-1 Spread -0,04% 0,17 -0,09 0,06 -0,05 0,84 (-0,42) (6,85) (-2,40) (2,78) (-2,05) Reported are loadings of the five value weighted NAV sorted portfolios on various factors. The factors are constructed as explained in section 5.1. Panel (A) reports loadings using the one-factor model. Panel (B) reports loadings using the three-factor model. Panel (C) reports loadings using the four-factor model. All alphas are reported on a monthly basis. The spread portfolios are built by subtracting the returns on the portfolio containing the smallest funds (portfolio 1) from the portfolio containing the largest funds (portfolio 5). T-values in parentheses.
Portfolio 5
Adj R-Squared 1,00
Results presented in table 6.11 display only small differences in the well-fit among the different model specifications. Moreover, the four-factor model does not improve the 51
Mutual Fund Performance in Europe The Role of Fund Size estimation of returns at all. Although portfolio five significantly loads on MOM, the substantial correlation of -0,57 between HML and MOM reduces the joint explanatory power of these two independent variables. All portfolios load positively on SMB and negatively on HML, whereas some of the coefficients are significant and some are not. Generally, the smaller the funds are the fewer is their exposure to the market. The spread portfolios exposure to the market is 0,09 and significant at the one per cent level. All portfolios under-perform the market, a significant result for portfolios two and three. Nevertheless, under-performance is only marginal for portfolio two. An alpha of 0,03 per cent when estimated with the four-factor model indicates that portfolio two delivers risk-adjusted net returns almost as good as the market.
Table 6.11 Portfolio Returns Spain Europe Panel A: Single-Factor Model Monthly Excess Std Portfolio Return Dev Alpha 5 0,43% 5,57% -0,21% (-2,05) 4 0,59% 5,31% -0,01% (-0,14) 3 0,38% 5,39% -0,23% (-2,05) 2 0,29% 5,13% -0,29% (-2,96) 1 0,33% 5,19% -0,26% (-2,06) 5-1 Spread 0,10% 1,34% 0,05% (0,41) Panel B: Three-Factor Model
Portfolio 5 4 3 2 1 5-1 Spread Alpha -0,17% (-1,69) -0,02% (-0,21) -0,25% (-2,17) -0,30% (-2,97) -0,26% (-2,10) 0,10% (0,77) Market 1,12 (55,15) 1,08 (56,30) 1,09 (46,04) 1,03 (48,74) 1,04 (39,98) 0,08 (30,21) SMB 0,06 (1,38) 0,12 (2,90) 0,13 (2,50) 0,05 (0,97) 0,12 (2,13) -0,06 (-1,04)
Market 1,11 (54,60) 1,06 (55,76) 1,07 (46,35) 1,02 (51,10) 1,02 (40,57) 0,09 (3,59)
Adj R-Squared 0,97 0,97 0,95 0,96 0,94 0,10
HML -0,09 (-3,59) -0,05 (-1,98) -0,04 (-1,37) -0,01 (-0,23) -0,05 (-1,44) -0,05 (-1,35)
Adj R-Squared 0,97 0,97 0,96 0,96 0,94 0,11
52

Adj Alpha Market SMB HML MOM R-Squared -0,19% 1,12 0,04 -0,05 0,05 0,97 (-1,97) (56,04) (0,77) (-1,55) (2,22) 4 -0,03% 1,08 0,12 -0,04 0,01 0,97 (-0,27) (55,76) (2,64) (-1,23) (0,56) 3 -0,26% 1,09 0,12 -0,02 0,02 0,95 (-2,25) (45,75) (2,18) (-0,56) (0,87) 2 -0,30% 1,03 0,05 -0,02 -0,01 0,96 (-2,88) (48,15) (1,06) (-0,47) (-0,48) 1 -0,24% 1,03 0,15 -0,09 -0,05 0,94 (-1,90) (39,89) (2,55) (-2,24) (-1,80) 5-1 Spread 0,05% 0,09 -0,12 0,04 0,10 0,20 (0,39) (3,61) (-2,03) (1,09) (3,65) Reported are loadings of the five value weighted NAV sorted portfolios on various factors. The factors are constructed as explained in section 5.1. Panel (A) reports loadings using the one-factor model. Panel (B) reports loadings using the three-factor model. Panel (C) reports loadings using the four-factor model. All alphas are reported on a monthly basis. The spread portfolios are built by subtracting the returns on the portfolio containing the smallest funds (portfolio 1) from the portfolio containing the largest funds (portfolio 5). T-values in parentheses. Portfolio 5
Table 6.12 shows results obtained from estimating the three model specifications on size portfolios of Spanish equity mutual funds with a worldwide investment focus. As in the countries investigated previously, the three- and four factor models deliver a better estimate of risk-adjusted returns than the single-factor model. All portfolios load negatively and significantly on SMB. Large funds seem to favour growth investing, as they load negatively on HML, the value premium. As in previous regression estimations, MOM does not significantly help to explain the portfolio returns. As previous examinations of globally investing funds also showed, smaller funds take less exposure to market risk than larger funds. While portfolio five has a market beta of 1,05, portfolio ones market beta is 0,98 when estimated with the four-factor model.
Table 6.12 Portfolio Returns Spain Global Panel A: Single-Factor Model Monthly Excess Std Portfolio Return Dev Alpha 5 0,01% 5,93% -0,27% (-1,00) 4 0,16% 5,61% -0,10% (-0,41) 3 0,12% 5,59% -0,14% (-0,56) 2 -0,08% 5,60% -0,34% (-1,29) 1 -0,09% 5,36% -0,34% (-1,45) 5-1 Spread 0,10% 1,90% 0,08% (0,45)
Market 1,08 (19,51) 1,03 (19,97) 1,03 (20,16) 1,01 (18,68) 0,98 (19,85) 0,10 (2,82)
Adj R-Squared 0,76 0,77 0,77 0,75 0,77 0,06
53

Table 6.12 Continued Panel B: Three-Factor Model
Alpha -0,27% (-1,31) 4 -0,20% (-0,95) 3 -0,26% (-1,26) 2 -0,48% (-2,05) 1 -0,48% (-2,32) 5-1 Spread 0,21% (1,53) Panel C: Four-Factor Model Portfolio 5 Portfolio 5 Market 1,04 (23,79) 1,02 (23,03) 1,02 (23,54) 1,02 (20,61) 0,99 (22,55) 0,05 (1,80) SMB -0,33 (-3,15) -0,49 (-4,72) -0,55 (-5,37) -0,57 (-4,85) -0,55 (-5,37) 0,23 (3,35) HML -0,30 (-5,68) -0,12 (-2,24) -0,08 (-1,53) 0,00 (0,03) -0,02 (-0,30) -0,28 (-8,08) Adj R-Squared 0,86 0,84 0,84 0,80 0,83 0,39
Adj Alpha Market SMB HML MOM R-Squared -0,31% 1,05 -0,36 -0,26 0,05 0,86 (-1,45) (23,51) (-3,25) (-3,72) (0,88) 4 -0,19% 1,02 -0,49 -0,12 -0,01 0,84 (-0,90) (22,51) (-4,30) (-1,77) (-0,13) 3 -0,28% 1,03 -0,57 -0,06 0,03 0,84 (-1,32) (23,15) (-5,15) (-0,82) (0,51) 2 -0,46% 1,02 -0,54 -0,02 -0,03 0,80 (-1,93) (20,09) (-4,30) (-0,28) (-0,47) 1 -0,43% 0,98 -0,50 -0,07 -0,07 0,83 (-2,05) (21,98) (-4,50) (-1,08) (-1,39) 5-1 Spread 0,13% 0,07 0,14 -0,18 0,12 0,44 (0,94) (2,48) (1,94) (-4,15) (3,41) Reported are loadings of the five value weighted NAV sorted portfolios on various factors. The factors are constructed as explained in section 5.1. Panel (A) reports loadings using the one-factor model. Panel (B) reports loadings using the three-factor model. Panel (C) reports loadings using the four-factor model. All alphas are reported on a monthly basis. The spread portfolios are built by subtracting the returns on the portfolio containing the smallest funds (portfolio 1) from the portfolio containing the largest funds (portfolio 5). T-values in parentheses.
Although under-performance is only significant for the smallest portfolio, all other portfolios also under-perform the market on a risk-adjusted basis. The spread portfolios positive alpha is insignificant as well.
6.5 The effect of fund size in the UK

Table 6.13 depicts results found for UK equity mutual funds with a domestic investment objective. By looking at the coefficient on SMB the enormous exposure to this factor for each portfolio becomes obvious. More than in any other investigated country all portfolios load positively on SMB. As the R2s of the three- and four factor models indicate, MOM does not add much explanatory power to the model. Neither does HML, which is only significant for portfolio one. Larger funds seem to have a preference for growth stocks.
54
Mutual Fund Performance in Europe The Role of Fund Size Market betas are all below one, with portfolio one having the smallest exposure to market risk with a market beta of 0,87 when estimated with the four-factor model.
Table 6.13 Portfolio Returns UK Domestic
Monthly Excess Return 0,16% 0,07% 0,09% 0,29% 0,29% -0,13%
Std Dev 4,56% 4,67% 4,81% 4,86% 4,95% 1,48%
Alpha -0,19% (-1,75) -0,29% (-2,49) -0,27% (-1,82) -0,07% (-0,51) -0,08% (-0,40) -0,11% (-0,75)
Market 0,95 (41,24) 0,97 (39,27) 0,98 (31,45) 1,00 (32,89) 0,99 (24,75) 0 (-1,12)
Adj R-Squared 0,95 0,94 0,91 0,92 0,87 0,00
Alpha -0,24% (-2,38) -0,35% (-3,18) -0,38% (-3,32) -0,18% (-1,56) -0,24% (-1,70) -0,01% (-0,04)
Market 0,91 (38,27) 0,93 (36,50) 0,91 (34,05) 0,93 (34,66) 0,87 (26,79) 0,04 (1,32)
SMB 0,09 (3,41) 0,12 (4,06) 0,25 (8,06) 0,23 (7,47) 0,34 (8,99) -0,24 (-7,42)
HML 0,06 (2,31) 0,02 (0,59) -0,03 (-0,96) -0,02 (-0,60) 0,02 (0,75) 0,03 (1,07)
Adj R-Squared 0,95 0,95 0,95 0,95 0,93 0,37
Adj Alpha Market SMB HML MOM R-Squared -0,24% 0,91 0,09 0,06 0,01 0,95 (-2,38) (38,03) (3,11) (2,04) (0,24) 4 -0,35% 0,93 0,11 0,03 0,02 0,95 (-3,22) (36,39) (3,57) (0,89) (0,71) 3 -0,37% 0,91 0,26 -0,05 -0,03 0,95 (-3,23) (33,98) (7,97) (-1,42) (-1,12) 2 -0,18% 0,93 0,23 -0,01 0,01 0,95 (-1,58) (34,47) (6,85) (-0,26) (0,41) 1 -0,23% 0,87 0,35 0,00 -0,03 0,93 (-1,62) (26,70) (8,79) (0,06) (-0,99) 5-1 Spread -0,02% 0,04 -0,26 0,06 0,03 0,38 (-0,15) (1,40) (-7,47) (1,65) (1,35) Reported are loadings of the five value weighted NAV sorted portfolios on various factors. The factors are constructed as explained in section 5.1. Panel (A) reports loadings using the one-factor model. Panel (B) reports loadings using the three-factor model. Panel (C) reports loadings using the four-factor model. All alphas are reported on a monthly basis. The spread portfolios are built by subtracting the returns on the portfolio containing the smallest funds (portfolio 1) from the portfolio containing the largest funds (portfolio 5). T-values in parentheses. Portfolio 5
55
Mutual Fund Performance in Europe The Role of Fund Size The three larger portfolios three to five significantly under-perform the market, while the two smaller portfolios also under-perform but statistically indistinguishable from zero. Moreover, the spread portfolios alpha is negative and insignificant. Results relating to UK funds investing in European stocks are displayed in table 6.14. With respect to estimations for the continental European countries, the model fit is not as good as expected. This holds regardless of the model specification. Regarding SMB the same effect that is observable for domestically investing UK funds is also observed in this context. The smaller the funds are the higher are their loadings on SMB. This results in a significantly negative exposure to SMB for the spread portfolio. In contrast, the factors HML and MOM do not help much to explain the returns obtained from investing in either of the five size portfolios. Market betas are below one throughout all portfolios, indicating that equity mutual funds in the UK are less exposed to market risk. All size portfolios under-perform the market, but none of them significantly.
Table 6.14 Portfolio Returns UK European Panel A: Single-Factor Model Monthly Excess Std Portfolio Return Dev Alpha 5 0,18% 4,69% -0,04% (-0,21) 4 0,10% 4,87% -0,13% (-0,65) 3 0,11% 4,94% -0,07% (-0,57) 2 0,28% 5,03% 0,04% (0,21) 1 0,27% 4,96% 0,05% (0,20) 5-1 Spread -0,09% 1,17% -0,09% (-0,72) Panel B: Three-Factor Model
Portfolio 5 4 3 2 1 5-1 Spread Alpha -0,16% (-0,82) -0,25% (-1,27) -0,27% (-1,38) -0,09% (-0,46) -0,15% (-0,68) -0,01% (-0,12) Market 0,91 (22,83) 0,94 (23,44) 0,96 (23,90) 0,97 (23,37) 0,95 (21,78) -0,05 (-2,16) SMB 0,22 (2,39) 0,21 (2,21) 0,44 (4,70) 0,42 (4,34) 0,51 (5,08) -0,29 (-5,97)
Market 0,88 (22,20) 0,92 (22,85) 0,92 (21,34) 0,94 (21,20) 0,91 (18,99) -0,02 (-0,99)
Adj R-Squared 0,84 0,85 0,83 0,83 0,79 0,00
HML 0,05 (1,08) 0,07 (1,33) -0,02 (-0,40) -0,03 (-0,62) 0,00 (-0,07) 0,06 (2,16)
Adj R-Squared 0,85 0,85 0,86 0,85 0,83 0,29
56

Adj Alpha Market SMB HML MOM R-Squared -0,15% 0,90 0,23 0,04 -0,02 0,84 (-0,78) (22,28) (2,37) (0,61) (-0,38) 4 -0,25% 0,94 0,22 0,05 -0,02 0,85 (-1,23) (22,88) (2,20) (0,81) (-0,36) 3 -0,25% 0,95 0,47 -0,06 -0,05 0,86 (-1,27) (23,34) (4,81) (-1,01) (-1,11) 2 -0,09% 0,97 0,43 -0,05 -0,02 0,85 (-0,42) (22,80) (4,23) (-0,74) (-0,42) 1 -0,12% 0,94 0,56 -0,06 -0,06 0,83 (-0,57) (21,25) (5,21) (-0,80) (-1,20) 5-1 Spread -0,03% -0,04 -0,32 0,09 0,04 0,30 (-0,30) (-1,83) (-6,29) (2,81) (1,78) Reported are loadings of the five value weighted NAV sorted portfolios on various factors. The factors are constructed as explained in section 5.1. Panel (A) reports loadings using the one-factor model. Panel (B) reports loadings using the three-factor model. Panel (C) reports loadings using the four-factor model. All alphas are reported on a monthly basis. The spread portfolios are built by subtracting the returns on the portfolio containing the smallest funds (portfolio 1) from the portfolio containing the largest funds (portfolio 5). T-values in parentheses. Portfolio 5
Table 6.15 reports results relating to UK funds investing with a worldwide investment objective. While none of the portfolios loads significantly on HML or MOM in either direction, all portfolios have a negative and significant exposure to SMB. Contrary to what is found for UK funds with a Domestic or European investment focus, globally investing UK funds seem to prefer investments in large cap stocks. Market betas all range above one. Smaller funds are considerably less exposed to market risk than larger funds. This is why the spread portfolio loads positively and significantly on the market.
Table 6.15 Portfolio Returns UK Global Panel A: Single-Factor Model Monthly Excess Std Portfolio Return Dev 5 0,11% 5,90%
4 3 2 1 5-1 Spread 0,23% 0,11% 0,11% 0,14% -0,03% 5,72% 5,53% 5,63% 5,61% 1,07%
Alpha -0,10% (-0,40) 0,02% (0,08) -0,09% (-0,38) -0,09% (-0,37) -0,06% (-0,22) -0,04% (-0,40)
Market 1,09 (21,63) 1,06 (21,94) 1,02 (20,75) 1,03 (19,91) 1,02 (19,50) 0,07 (3,50)
Adj R-Squared 0,83 0,83 0,82 0,81 0,80 0,11
57

Table 6.15 Continued Panel B: Three-Factor Model
Alpha -0,09% (-0,36) 4 0,03% (0,13) 3 -0,08% (-0,34) 2 -0,08% (-0,33) 1 -0,04% (-0,18) 5-1 Spread -0,04% (-0,41) Panel C: Four-Factor Model Portfolio 5 Portfolio 5 Market 1,10 (22,40) 1,07 (22,90) 1,02 (21,11) 1,04 (20,73) 1,03 (20,20) 0,07 (3,46) SMB -0,34 (-2,27) -0,34 (-3,18) -0,27 (-2,39) -0,36 (-3,12) -0,35 (-2,96) 0,01 (0,21) HML 0,00 (0,03) -0,01 (-0,21) 0,01 (0,29) 0,00 (0,06) 0,01 (0,15) -0,01 (-0,27) Adj R-Squared 0,84 0,85 0,83 0,82 0,81 0,09
Adj Alpha Market SMB HML MOM R-Squared -0,09% 1,10 -0,34 0,00 0,00 0,84 (-0,36) (22,28) (-2,92) (0,05) (0,03) 4 0,03% 1,07 -0,34 -0,01 0,01 0,85 (0,13) (22,78) (-3,11) (-0,09) (0,13) 3 -0,08% 1,02 -0,27 0,01 -0,01 0,82 (-0,33) (20,99) (-2,37) (0,14) (-0,16) 2 -0,08% 1,04 -0,36 -0,01 -0,02 0,82 (-0,31) (20,62) (-3,13) (-0,18) (-0,37) 1 -0,04% 1,03 -0,35 -0,01 -0,02 0,81 (-0,16) (20,09) (-2,97) (-0,09) (-0,35) 5-1 Spread -0,05% 0,07 0,02 0,01 0,02 0,09 (-0,44) (3,47) (0,34) (0,32) (0,90) Reported are loadings of the five value weighted NAV sorted portfolios on various factors. The factors are constructed as explained in section 5.1. Panel (A) reports loadings using the one-factor model. Panel (B) reports loadings using the three-factor model. Panel (C) reports loadings using the four-factor model. All alphas are reported on a monthly basis. The spread portfolios are built by subtracting the returns on the portfolio containing the smallest funds (portfolio 1) from the portfolio containing the largest funds (portfolio 5). T-values in parentheses.
With respect to performance, the sample of UK funds investing with a worldwide objective is exceptional. First, size portfolios one to three and five only marginally under-perform the market on a risk-adjusted basis regardless of the model specification. Second, size portfolio four is the only portfolio in all five countries and over all three geographic investment regions that out-performs the market. Admittedly, the alpha of 0.03 per cent is small and statistically insignificant but still positive.
58
6.6 Extreme Portfolios

As shown in the previous section, 14 of 15 spread portfolio alphas are insignificant. Nevertheless, it is too early to conclude that fund size does not have a significant impact on fund performance. It is interesting to see whether this still holds when not looking at quintile but on more extreme portfolios. This is why portfolio construction is altered for the upcoming investigation. Fund portfolios now contain exactly 20 funds for funds investing with global and European investment objectives and 15 funds for those funds investing in domestic stocks. The large portfolio contains the 20 or 15 largest funds in each year of the respective sample period. The 20 or 15 smallest funds are contained in the small portfolio. Due to the relative definition of size in the previous investigation, the largest portfolio of German globally investing funds, portfolio five, contains 257 funds in the year 2004. Therefore, portfolio fives largest fund is 41 times larger than portfolio fives smallest fund. Hence, while these funds are both considered large in a relative sense, their size is especially different in an absolute sense. The limitation to 20 or 15 funds per portfolio mitigates this problem. Thus, this method leaves only extremely large and small funds in the sample and excludes the other ones. Tables 6.16 through 6.20 display results for extreme portfolios as well as for spread portfolios relating to French, German, Italian, Spanish and UK funds investing domestically, in Europe and worldwide. Apart from a few minor differences, results presented in this section resemble the ones obtained in the previous section. Especially the results for domestically investing funds are almost identical because the quintile portfolios already contain a limited number of funds. The only significant spread portfolio alpha in the preceding analysis is the one for French equity mutual funds with a Europe wide investment objective. The corresponding alpha in this section is displayed in table 6.16. The t-value of 1.96 indicates that this alpha is only marginally significant. As depicted in table 6.17, large German funds investing in European stocks under perform the market by a monthly -0,07 per cent when estimated with the four-factor model. The corresponding small funds under perform the market by -0,72 per cent, a number which is significant at the one per cent level. This performance difference results in the spread portfolio outperforming the market by a significant monthly 0,65 per cent. Results for the Italian and Spanish market presented in tables 6.18 and 6.19 indicate that altering the portfolio construction has only a slight impact on the results for these countries. 59
Mutual Fund Performance in Europe The Role of Fund Size Results relating to the UK market are presented in table 6.20. They signify an out performance of small funds investing globally and in Europe. Small funds investing in Europe out perform the market by a monthly 0,07 per cent while small funds investing all around the globe out perform the market by 0,14 per cent monthly. Although this results in a yearly out performance of 1,68 per cent for the latter funds, this number is statistically indistinguishable from zero. Over all, spread portfolio alphas displayed in this section have exactly the same sign as the corresponding spread portfolio alphas in the previous section. The only difference concerns changes in significance levels as in the case of French and German funds investing in Europe.
Table 6.16 Extreme Portfolio Returns France
Panel A: Domestic
Portfolio Large Small 2-1 Spread

Panel B: Europe
Alpha -0,54% (-3,31) -1,05% (-3,25) 0,51% (1,78)
Market 0,92 (23,77) 1,19 (15,38) -0,26 (-3,84)
SMB 0,10 (1,49) 0,83 (6,56) -0,74 (-6,54)
HML 0,08 (1,81) -0,10 (-1,18) 0,18 (2,35)
MOM -0,04 (-1,28) -0,13 (-1,93) 0,09 (1,45)
Adj R-Squared 0,96 0,91 0,52

Panel C: Global
Alpha -0,11% (-1,13) -0,39% (-2,79) 0,28% (1,96)
Market 1,07 (50,14) 1,12 (37,39) -0,05 (-1,52)
SMB 0,03 (0,57) 0,37 (5,44) -0,34 (-4,98)
HML -0,02 (-0,71) -0,03 (-0,62) 0,01 (0,11)
MOM 0,03 (1,27) -0,07 (-2,22) 0,10 (3,10)
Adj R-Squared 0,96 0,93 0,20
Adj Alpha Market SMB HML MOM R-Squared -0,33% 1,08 -0,43 -0,19 0,07 0,87 (-1,52) (23,50) (-3,87) (-2,62) (1,37) Small -0,12% 0,90 -0,57 0,14 0,09 0,71 (-0,43) (15,61) (-4,08) (1,54) (1,27) 2-1 Spread -0,21% 0,18 0,14 -0,32 -0,01 0,39 -(1,00) (3,94) (1,28) (-4,65) (-0,23) Reported in each Panel are loadings of the two value weighted NAV sorted portfolios on various factors. The factors are constructed as explained in section 5.1. Panel (A) reports loadings of funds investing in the domestic market. Panel (B) reports loadings of funds investing in the European market. Panel (C) reports loadings of funds investing in the global market. All alphas are reported on a monthly basis. The spread portfolios are built by subtracting the returns on the portfolio containing small funds (portfolio Small) from the portfolio containing large funds (portfolio Large). Tvalues in parentheses. Portfolio Large
60

Table 6.17 Extreme Portfolio Returns Germany
Panel A: Domestic

Panel B: Europe
Alpha -0,52% (-2,61) -0,66% (-3,20) 0,14% (1,29)
Market 1,13 (18,82) 1,26 (20,34) -0,13 (-4,05)
SMB 0,00 (0,05) 0,35 (4,21) -0,34 (-8,01)
HML 0,07 (1,37) -0,01 (-0,14) 0,08 (2,83)
MOM -0,08 (-2,26) -0,11 (-3,03) 0,03 (1,61)
Adj R-Squared 0,95 0,94 0,59

Panel C: Global
Alpha -0,07% (-0,47) -0,72% (-4,84) 0,65% (3,13)
Market 1,01 (31,24) 1,09 (34,51) -0,08 (-1,77)
SMB -0,25 (-3,34) 0,32 (4,39) -0,56 (-5,61)
HML 0,04 (0,74) 0,01 (0,25) 0,03 (0,37)
MOM 0,14 (3,97) -0,04 (-1,18) 0,19 (3,77)
Adj R-Squared 0,91 0,91 0,25
Adj Alpha Market SMB HML MOM R-Squared -0,24% 0,98 -0,53 -0,24 0,03 0,89 (-1,48) (27,93) (-6,12) (-4,44) (0,76) Small -0,31% 0,98 -0,38 -0,09 -0,03 0,78 (-1,36) (19,97) (-3,14) (-1,12) (-0,50) 2-1 Spread 0,07% -0,01 -0,15 -0,16 0,06 0,20 (0,39) (-0,15) (-1,49) (-2,50) (1,28) Reported in each Panel are loadings of the two value weighted NAV sorted portfolios on various factors. The factors are constructed as explained in section 5.1. Panel (A) reports loadings of funds investing in the domestic market. Panel (B) reports loadings of funds investing in the European market. Panel (C) reports loadings of funds investing in the global market. All alphas are reported on a monthly basis. The spread portfolios are built by subtracting the returns on the portfolio containing small funds (portfolio Small) from the portfolio containing large funds (portfolio Large). Tvalues in parentheses. Portfolio Large
Table 6.18 Extreme Portfolio Returns Italy

Panel A: Domestic

Panel B: Europe
Alpha -0,22% (-1,04) -0,26% (-1,06) 0,04% (0,50)
Market 0,76 (15,50) 0,85 (14,93) -0,08 (-4,74)
SMB 0,04 (0,36) 0,33 (2,58) -0,29 (-7,23)
HML 0,04 (0,59) -0,04 (-0,56) 0,08 (3,40)
MOM -0,14 (-2,68) -0,13 (-2,18) -0,01 (-0,45)
Adj R-Squared 0,91 0,90 0,61
Alpha -0,11% (-0,88) -0,30% (-2,66) 0,19% (1,27)
Market 1,05 (38,14) 1,08 (44,54) -0,03 (-0,83)
SMB -0,05 -(0,84) -0,30 (5,37) -0,35 (-4,87)
HML -0,02 (-0,38) 0,00 (0,05) -0,02 (-0,37)
MOM 0,08 (2,50) 0,00 (0,04) 0,08 (2,16)
Adj R-Squared 0,93 0,95 0,18
61

Table 6.18 Continued
Panel C: Global
Adj Alpha Market SMB HML MOM R-Squared -0,33% 0,93 -0,45 -0,24 -0,01 0,89 (-2,17) (27,81) (-5,48) (-4,56) (-0,34) Small -0,34% 1,01 -0,31 -0,19 -0,15 0,79 (-1,48) (20,23) (-2,55) (-2,43) (-2,48) 2-1 Spread 0,01% -0,08 -0,14 -0,05 0,13 0,15 (0,03) (-1,87) (-1,38) (-0,78) (-2,75) Reported in each Panel are loadings of the two value weighted NAV sorted portfolios on various factors. The factors are constructed as explained in section 5.1. Panel (A) reports loadings of funds investing in the domestic market. Panel (B) reports loadings of funds investing in the European market. Panel (C) reports loadings of funds investing in the global market. All alphas are reported on a monthly basis. The spread portfolios are built by subtracting the returns on the portfolio containing small funds (portfolio Small) from the portfolio containing large funds (portfolio Large). Tvalues in parentheses. Portfolio Large
Table 6.19 Extreme Portfolio Returns Spain

Panel A: Domestic

Panel B: Europe
Alpha -0,39% (-5,39) -0,34% (-3,44) -0,06% -(0,60)
Market 1,11 (57,03) 0,95 (36,29) 0,17 (6,42)
SMB -0,02 (-0,80) 0,06 (1,63) -0,09 (-2,23)
HML 0,10 (6,22) 0,05 (2,29) 0,05 (2,37)
MOM -0,04 (-1,95) 0,01 (0,37) -0,05 (-1,83)
Adj R-Squared 0,99 0,99 0,81

Panel C: Global
Alpha -0,19% (-1,83) -0,21% (-1,76) 0,02% (0,16)
Market 1,12 (52,60) 1,02 (41,60) 0,10 (3,67)
SMB 0,01 (0,19) 0,15 (2,66) -0,14 (-2,28)
HML -0,04 (-1,27) -0,06 (-1,44) 0,01 (0,30)
MOM 0,06 (2,53) -0,01 (-0,29) 0,07 (2,27)
Adj R-Squared 0,97 0,95 0,18
Adj Alpha Market SMB HML MOM R-Squared -0,12% 0,96 -0,25 -0,29 0,10 0,79 (-0,48) (18,26) (-1,92) (-3,54) (1,58) Small -0,36% 0,95 -0,50 -0,08 -0,09 0,83 -(1,74) (22,13) (-4,68) (-1,24) (-1,70) 2-1 Spread 0,23% 0,01 0,25 -0,21 0,19 0,36 (1,17) (0,29) (2,37) (-3,18) (3,73) Reported in each Panel are loadings of the two value weighted NAV sorted portfolios on various factors. The factors are constructed as explained in section 5.1. Panel (A) reports loadings of funds investing in the domestic market. Panel (B) reports loadings of funds investing in the European market. Panel (C) reports loadings of funds investing in the global market. All alphas are reported on a monthly basis. The spread portfolios are built by subtracting the returns on the portfolio containing small funds (portfolio Small) from the portfolio containing large funds (portfolio Large). Tvalues in parentheses. Portfolio Large
62

Table 6.20 Extreme Portfolio Returns UK
Panel A: Domestic

Panel B: Europe
Alpha -0,26% (-2,44) -0,18% (-1,35) -0,07% (-0,57)
Market 0,92 (37,59) 0,85 (26,51) 0,08 (2,56)
SMB 0,09 (2,85) 0,36 (9,33) -0,28 (-7,73)
HML 0,06 (2,00) -0,04 (-1,02) 0,10 (2,77)
MOM 0,01 (0,37) 0,00 (0,05) 0,01 (0,25)
Adj R-Squared 0,95 0,93 0,44

Panel C: Global
Alpha -0,15% (-0,77) 0,07% (0,31) -0,23% (-1,62)
Market 0,90 (22,24) 0,93 (18,79) -0,03 (-1,07)
SMB 0,22 (2,26) 0,65 (5,45) -0,43 (-6,24)
HML 0,07 (1,04) -0,16 (-2,04) 0,22 (5,00)
MOM -0,01 (-0,17) -0,07 (-1,23) 0,06 (1,88)
Adj R-Squared 0,84 0,80 0,38
Adj Alpha Market SMB HML MOM R-Squared -0,10% 1,11 -0,34 0,00 0,01 0,84 (-0,40) (22,08) (-2,90) (-0,05) (0,11) Small 0,14% 0,99 -0,31 0,02 0,00 0,78 (0,54) (18,16) (-2,44) (0,34) (0,03) 2-1 Spread -0,24% 0,12 -0,03 -0,03 0,00 0,14 (-1,77) (4,35) (-0,46) (-0,76) (0,14) Reported in each Panel are loadings of the two value weighted NAV sorted portfolios on various factors. The factors are constructed as explained in section 5.1. Panel (A) reports loadings of funds investing in the domestic market. Panel (B) reports loadings of funds investing in the European market. Panel (C) reports loadings of funds investing in the global market. All alphas are reported on a monthly basis. The spread portfolios are built by subtracting the returns on the portfolio containing small funds (portfolio Small) from the portfolio containing large funds (portfolio Large). Tvalues in parentheses. Portfolio Large
6.7 Small Cap Funds

In their 2004 article, Chen et al (2004) investigate the so-called liquidity hypothesis. This hypothesis states that fund size erodes fund performance for those funds investing in small cap stocks. Because smaller stocks tend to be illiquid, trading costs and the costs of larger price impacts due to trading are supposed to have a larger negative impact on larger funds than on smaller ones. The authors obtain results consistent with the liquidity hypothesis and conclude that for normal funds, fund size does not affect performance while it does have a huge negative impact on small cap funds. Furthermore, a growth in assets under management is supposed to create more difficulties for small cap stocks. While limited to small cap stocks, there might not be enough attractive investment goals for a large asset base to be invested by larger funds. In this section, the liquidity hypothesis is tested for European small cap funds in a time-series framework. 63
Mutual Fund Performance in Europe The Role of Fund Size The merged database described in section four contains information on geographical as well as style objectives of the equity mutual funds. Data relating to the four continental European countries is comprehensive enough to form size portfolios of funds investing in European small cap stocks. The UK sample does not offer a broad enough dataset to elaborate on the exact same matter in the UK market. Instead, the UK sample offers enough data to examine funds investing in domestic small cap stocks. Remember from the previous sections that of twelve spread portfolio alphas only two were negative while the other ten spread portfolios yielded positive alphas. Table 6.21 displays results obtained from estimating returns for portfolios containing large and small small cap funds as well as a spread portfolio. As expected, all portfolios but the ones for the UK load significantly and positively on SMB. For some portfolios, loadings on SMB are almost as high as loadings on the market proxy. Strikingly, UK funds loadings on SMB, although positive, lack significance. This casts doubt on the correct specification of the SMB factor for the UK. In most countries, investing in small cap stocks corresponds to investing in growth stocks as indicated by the negative loadings on HML for all of the portfolios except the small Spanish one. Interestingly, both small cap fund portfolios in France out perform the market on a risk-adjusted basis. This also counts for the portfolios containing small small cap funds in Germany and Italy. While all portfolios yield negative alphas, spread portfolio alphas are negative in every country but France. Even though these results are statistically insignificant as indicated by the corresponding t-values, they represent a sharp contrast to what is obtained in previous sections. Consistent with what Chen et al (2004), they indicate the presence of a liquidity effect for small cap funds.
Table 6.21 Small Cap Fund Returns
Panel A: France (European)
Portfolio 2 1 2-1 Spread
Alpha 0,12% (0,62) 0,10% (0,33) 0,02% (0,08)
Market 1,28 (28,24) 1,07 (15,46) 0,21 (3,19)
SMB 0,93 (9,53) 0,64 (4,34) 0,28 (1,99)
HML -0,57 (-8,72) -0,27 (-2,69) -0,30 (-3,16)
MOM -0,09 (-1,83) 0,22 (3,13) -0,31 (-4,53)
Adj R-Squared 0,94 0,80 0,36
Panel B: Germany (European)
Alpha -0,11% (-0,80) 0,04% (0,22) -0,15% (-1,19)
Market 1,29 (43,49) 1,25 (32,93) 0,04 (1,39)
SMB 1,23 (18,04) 1,11 (12,73) 0,12 (1,88)
HML -0,60 (-12,28) -0,55 (-8,79) -0,05 (-1,11)
MOM -0,06 (-1,76) -0,04 (-0,92) -0,02 (-0,64)
Adj R-Squared 0,94 0,91 0,01
64

Panel C: Italy (European)
Alpha -0,15% (-0,94) 0,02% (0,13) -0,17% (-1,39)
Market 1,26 (36,46) 1,19 (30,69) 0,08 (2,89)
SMB 1,16 (14,72) 1,03 (11,80) 0,12 (2,02)
HML -0,50 (-8,86) -0,49 (-7,83) -0,01 (-0,17)
MOM -0,07 (-1,92) 0,04 (0,91) -0,11 (-3,79)
Adj R-Squared 0,93 0,90 0,19
Panel D: Spain (European)
Alpha -0,79% (-4,50) -0,73% (-4,50) -0,08% (-0,43)
Market 1,26 (29,69) 1,17 (29,77) 0,09 (1,86)
SMB 1,03 (11,53) 0,80 (9,61) 0,24 (2,64)
HML -0,22 (-3,08) 0,04 (0,66) -0,28 (-3,78)
MOM -0,09 (-1,90) -0,06 (-1,36) -0,03 (-0,53)
Adj R-Squared 0,96 0,96 0,27
Panel E: UK (Domestic)
Adj Alpha Market SMB HML MOM R-Squared -0,32% 0,78 0,81 -0,09 -0,07 0,91 (-1,71) (17,94) (1,51) (-1,64) (-1,88) 1 -0,31% 0,93 0,96 -0,26 -0,10 0,89 (-1,31) (16,65) (1,39) (-3,77) (-1,98) 2-1 Spread -0,01% -0,15 -0,15 0,17 0,02 0,37 (-0,04) (-4,26) (-3,50) (3,97) (0,82) Reported in each Panel are loadings of the two value weighted NAV sorted portfolios on various factors. The factors are constructed as explained in section 5.1. Panel (A) reports loadings of French funds investing in European small cap stocks. Panel (B) reports loadings of German funds investing in investing in European small cap stocks. Panel (C) reports loadings of Italian funds investing in European small cap stocks. Panel (D) reports loadings of Spanish funds investing in European small cap stocks. Panel (E) reports loadings of UK funds investing in domestic small cap stocks All alphas are reported on a monthly basis. The spread portfolios are built by subtracting the returns on the portfolio containing small funds (portfolio Small) from the portfolio containing large funds (portfolio Large). T-values in parentheses. Portfolio 2
6.8 Small Funds in Large Fund Families

Another finding from Chen et al (2004) concerns fund family size, defined as the fund providers aggregate size given by all funds provided. While mutual funds might not be able to profit from economies of scale on the individual fund level, economies of scale might be existent on the fund family level. As Chen et al (2004) point out, larger fund families profit from economies associated with trading commissions and lending fees. Due to a higher bargaining power, large fund families are supposed to get concessions at more favourable prices. From an organizational point of view, the authors hypothesize that large fund families with different smaller funds should be able to perform best. Inspired by these findings this section attempts to test them in a time-series framework. Portfolios are formed that match the conditions laid out in the previous 65
Mutual Fund Performance in Europe The Role of Fund Size paragraph. In a first step, each year only funds belonging to the top 20 per cent of fund families as measured by their net asset value are considered. Therefore, the sample is restricted to fund families like Fidelity, UBS or JP Morgan Fleming. In addition to these multinational players, each country has a few large domestic providers. These are e.g. Atout in France, Deka in Germany or Nextra in Italy. In a second step, only the smallest funds of these largest fund families are considered. As for the extremely large and small portfolios formed in section 6.6, portfolios are restricted to 20 funds for funds investing worldwide and in Europe and to 15 for funds investing in their respective home market. Results for the described portfolios are presented in table 6.22. Unfortunately, R2s are quite low for most of the portfolios of globally investing equity mutual funds. This is especially true for Spain, where returns of globally investing funds are estimated with an R2 of 0,57. Nevertheless, the low R2 is not attributable to the model specification. The insufficient explanatory power of the model originates in the portfolio composition. Small funds of large fund families are mostly regional funds confined to investments in specific countries such as Malaysia, Taiwan or Indonesia. To put this into perspective, 60 per cent of the funds belonging to the sample of Spanish funds with a global investment objective were regional funds. Because market integration is much lower among global countries than among European countries, regional funds have a more destructive effect in portfolios of globally investing funds. The portfolio size restriction to 20 funds even further magnifies this problem. The portfolios alphas indicate that small funds belonging to large families do in general not perform better than other funds. The magnitude of the funds under performance with respect to the market is about the same as the magnitude obtained for the size quintile portfolios investigated in section 6.1 through 6.5.
Table 6.22 Fund Family Returns
Panel A: France
Portfolio Europe Global

Panel B: Germany
Alpha -0,17% (-1,15) -0,20% (-0,67)
Market 1,12 (34,01) 1,04 (16,60)
SMB 0,29 (4,13) -0,45 (-2,91)
HML -0,15 (-3,14) -0,08 (-0,87)
MOM -0,10 (-2,81) -0,02 (-0,29)
Adj R-Squared 0,95 0,73
Alpha -0,17% (-1,16) -0,37% (-1,79)
Market 1,15 (34,65) 0,95 (22,10)
SMB 0,11 (1,59) -0,61 (-5,64)
HML -0,22 (-4,57) 0,02 (0,29)
MOM -0,01 (-0,31) 0,10 (2,01)
66

Panel C: Italy

Panel D: Spain
Alpha -0,10% (-0,72) -0,28% (-1,61)
Market 1,08 (32,91) 0,89 (24,69)
SMB 0,26 (3,64) -0,43 (-4,74)
HML -0,20 (-4,26) -0,16 (-2,90)
MOM -0,03 (-1,02) -0,04 (-0,90)

Panel E: UK
Alpha -0,20% (-1,32) -0,43% (-1,28)
Market 1,09 (31,42) 0,83 (1,16)
SMB 0,37 (5,02) -0,25 (-1,43)
HML -0,10 (-2,08) -0,11 (-0,96)
MOM -0,05 (-1,27) -0,11 (-1,26)
Adj Alpha Market SMB HML MOM R-Squared -0,22% 0,96 0,55 -0,14 -0,08 0,86 (-0,95) (18,49) (4,86) (-1,92) (-1,40) Global -0,25% 1,04 -0,15 0,06 0,02 0,78 (-0,81) (15,94) (-0,97) (0,88) (0,34) Reported in each Panel are loadings of two equally weighted portfolios on various factors. Portfolios contain the smallest funds of the top 20% fund families as measured by their NAV each year. The factors are constructed as explained in section 5.1. Panel (A) reports loadings of French funds investing in Europe and worldwide. Panel (B) reports loadings of German funds investing in Europe and worldwide. Panel (C) reports loadings of Italian funds investing in Europe and worldwide. Panel (D) reports loadings of Spanish funds investing in Europe and worldwide. Panel (E) reports loadings of UK funds investing in Europe and worldwide. All alphas are reported on a monthly basis. T-values in parentheses. Portfolio Europe
67
7. Robustness Tests
In this section, results obtained in the previous sections are tested for robustness. First, a test for performance development is performed. By splitting the samples known from sections 6.1 through 6.5 into different sub periods, it is tested whether the results obtained so far are stable over time. Second, it is checked for timing as proposed by Henriksson and Merton (1981). All following tests are performed on samples different from the ones used in section six. This is either due to technical reasons as in the case of the test for survivorship bias, or it is due to a lack of data. Partitioning on size and other differences such as active/passive or offshore/non-offshore limits the portfolios to too few funds. As mentioned, the subsequent robustness test checks for survivorship bias first referred to by Brown et al (1992). Additionally, it is checked for potential return differences between funds domiciled in offshore locations and funds domiciled elsewhere. The subsequent analysis investigates whether mutual fund managers are able to add value due to active management. It is checked whether there is any return difference between active and passive mutual funds.
7.1 Performance Development

So far, a static picture of the equity mutual funds performance is obtained. However, performance might not always have been constant during the sample period. In order to account for potential performance differences, each of the samples from sections 6.1 through 6.5 is split in three non overlapping sub periods. As a minimum requirement, each sub period contains at least 24 observations. This is why some samples are only split into two sub periods. These samples are domestically investing funds in the continental European countries. The results are displayed in table 7.1. Despite some substantial differences among sub period alphas, alphas show no pattern over time. While hardly any alphas are positive over the entire sample periods, 19 of 84 size portfolio alphas are positive for a sub period. Of these 19 positive alphas, 15 are obtained for fund portfolios of continental European funds investing in Europe and worldwide in sub period two. This is the period between 1998 and 2002, where the market experienced extreme movements due to the bubble and its burst. However, developments in alpha have no relation to size. As can be seen by looking at the spread portfolios alphas over time, no pattern is detected.
68

Table 7.1 Performance Development
Panel A: France
Domestic
Portfolio 5 Portfolio 1 Spread Portfolio
Europe
Global
Alpha Period 1 -0,83% (-3,33) -1,47% (-2,36) 0,63% (1,08) -0,24% (-1,13) -0,48% (-1,80) 0,24% (0,88) -1,05% (-2,84) -1,04% (-2,50) -0,02% (-0,07) Alpha Period 1 0,06% (0,21) 0,13% (0,50) -0,07% (-0,58) -0,40% (-1,46) -0,26% (-1,17) -0,14% (-0,47) -0,69% (-2,12) -0,87% (-2,47) 0,18% (0,67)
Alpha Period 2 -0,30% (-1,44) -0,54% (-1,44) 0,24% (0,70) 0,17% (1,03) 0,01% (0,03) 0,16% (0,94) 0,38% (1,33) 0,39% (1,03) -0,01% (-0,04) Alpha Period 2 -0,91% (-2,18) -1,21% (-2,51) 0,30% (1,11) 0,10% (0,57) -0,06% (-0,41) 0,16% (1,07) 0,36% (1,35) 0,38% (1,10) -0,01% (-0,06)
Alpha Period 3 n/a n/a n/a -0,35% (-3,03) -0,45% (-3,04) 0,11% (0,85) -0,33% (-1,30) -0,21% (-0,72) -0,12% (-0,53) Alpha Period 3 -0,14% (-0,35) -0,46% (-1,38) 0,32% (1,62) -0,35% (-3,22) -0,36% (-2,52) 0,01% (0,12) -0,24% (-1,23) -0,42% (-1,71) 0,18% (1,44)
Panel B: Germany
Domestic
Europe
Global
69

Table 7.1 Continued
Panel C: Italy
Domestic
Europe
Global
Alpha Period 1 -0,12% (-1,42) -0,09% (-0,77) -0,03% (-0,31) -0,09% (-0,29) -0,54% (-2,33) 0,46% (1,34) -0,74% (-2,85) -1,14% (-3,06) 0,40% (1,53) Alpha Period 1 -0,33% (-4,02) -0,46% (-2,53) 0,13% (0,86) -0,49% (-2,29) -0,35% (-1,19) -0,14% (-0,45) -0,60% (-1,72) -0,65% (-1,43) 0,05% (0,19)
Alpha Period 2 -0,23% (-3,19) -0,14% (-1,17) -0,09% (-0,82) 0,10% (0,60) 0,13% (0,88) -0,04% (-0,23) 0,26% (1,10) 0,43% (1,14) -0,17% (-0,67) Alpha Period 2 -0,21% (-2,01) -0,15% (-1,31) -0,06% (-0,63) 0,13% (0,73) 0,03% (0,11) 0,10% (0,51) 0,28% (0,75) 0,15% (0,44) 0,13% (0,51)
Alpha Period 3 n/a n/a n/a -0,27% (-2,96) -0,32% (-2,39) 0,05% (0,54) -0,29% (-1,46) -0,41% (-1,79) 0,12% (1,31) Alpha Period 3 n/a n/a n/a -0,28% (-2,91) -0,27% (-1,78) -0,01% (-0,11) -0,34% (-1,19) -0,23% (-1,00) -0,12% (-0,86)
Panel D: Spain
Domestic
Europe
Global
70

Table 7.1 Continued
Panel E: UK
Alpha Period 1 Alpha Period 2 Alpha Period 3 -0,11% -0,10% -0,28% (-0,54) (-0,52) (-2,31) Portfolio 1 0,12% -0,19% -0,40% (0,36) (-0,84) (-2,95) Spread Portfolio -0,22% 0,08% 0,12% (-0,68) (0,84) (1,64) Europe Portfolio 5 -0,25% -0,29% -0,28% (-0,6) (-0,75) (-0,79) Portfolio 1 -0,16% -0,42% -0,34% (-0,35) (-1,03) (-0,95) Spread Portfolio -0,09% 0,12% 0,06% (-0,32) (0,98) (0,60) Global Portfolio 5 -0,09% -0,63% -0,27% (-0,17) (-1,18) (-0,90) Portfolio 1 0,19% -0,71% -0,03% (0,33) (-1,28) (-0,09) Spread Portfolio -0,28% 0,08% -0,24% (-1,40) (0,45) (-1,23) Estimation of the four-factor model on the NAV sorted quintiles five and one and the spread portfolio (5-1) known from section 6. Returns are value-weighted. Reported are monthly alphas for different sub periods. All samples are split into sub periods of equal length. For all UK funds, the sample period is 1998/1 to 2005/12. Sample periods are 2001/1 to 2004/12 for French, Italian and Spanish domestic funds and 1999/1 to 2004/12 for German domestic funds. For funds investing in Europe, sample periods range from 1996/1 to 2005/12 in France, Germany and Italy and from 1997/1 to 2005/12 in Spain. For funds investing worldwide, sample periods range from 1995/1 to 2005/12 in France, Germany and Italy and from 1996/1 to 2005/12 in Spain. Reported are OLS estimates with Newey-West Heteroskedasticity and Autocorrelation consistent (HAC) standard errors. T-values in parentheses. Domestic Portfolio 5
7.2 Timing
Starting with Treynor and Mazuy (1966), numerous researchers attempt to investigate whether mutual fund managers are able to time the market. Normally, mutual fund managers are believed to select individual stocks that are over- or undervalued relative to other equities. However, apart from forecasting price movements of selected individual stocks, mutual fund managers could also try to engage in forecasting price movements of the entire stock market. While the former method is called micro-forecasting the latter is called macro-forecasting. In their 1966 model, Treynor and Mazuy introduce a model that is able to test for such macro-forecasting abilities of mutual fund managers. In the extended three-factor version, their model reads as follows: Rit Rft = i + 0i(Rmt Rft) + Ti(Rmt Rft)2+ 1iSMBt + 2iHMLt + it If the fund manager is able to time the market, Ti will be positive.
71
Table 7.2 Timing (Henriksson and Merton 1981)

Panel B: Germany Panel C: Italy Panel D: Spain Panel E: UK
Panel A: France
Domestic
Portfolio 5
Portfolio 1
Spread Portfolio
Alpha -0,84% (-2,57) -1,63% (-2,24) 0,79% (1,20)
HM 0,0057 (1,17) 0,0092 (0,84) -0,0035 (-0,35)
Alpha -0,39% (-1,02) -0,56% (-1,38) 0,17% (0,88)
HM -0,0039 (-0,60) -0,0030 (-0,43) -0,0009 (-0,27)
Alpha -0,28% (-2,86) -0,33% (-1,87) 0,05% (0,30)
HM 0,0021 (1,42) 0,0022 (0,82) -0,0001 (-0,03)
Alpha -0,35% (-2,58) -0,76% (-4,49) 0,41% (2,42)
HM 0,0000 (0,02) 0,0073 (2,84) -0,0072 (-2,81)
Alpha 0,16% (0,69) 0,31% (1,00) -0,17% (-0,61)
HM -0,0070 (-1,89) -0,0097 (-1,97) 0,0029 (0,66)
Europe
Portfolio 5
Portfolio 1
Spread Portfolio
Alpha 0,26% (1,29) -0,03% (-0,12) 0,29% (1,11)
HM -0,0063 (-2,06) -0,0068 (-1,59) 0,0004 (0,11)
Alpha 0,05% (0,21) -0,27% (-1,19) 0,32% (1,20)
HM -0,0040 (-1,11) -0,0012 (-0,36) -0,0027 (-0,68)
Alpha 0,43% (1,63) 0,05% (-0,01) 0,37% (1,33)
HM -0,0088 (-2,22) 0,2312 (-1,61) -0,0032 (-0,75)
Alpha 0,40% (1,97) -0,16% (-0,58) 0,55% (2,07)
HM -0,0099 (-3,15) -0,0019 (-0,45) -0,0080 (-1,92)
Alpha -0,76% (-1,91) -0,78% (-1,76) 0,01% (0,06)
HM 0,0106 (1,72) 0,0111 (1,63) -0,0005 (-0,14)
Alpha HM Alpha HM Alpha HM Alpha HM Alpha HM -0,26% -0,0014 -0,26% 0,0006 -0,40% 0,0017 0,09% -0,0062 -0,46% 0,0064 (-0,66) (-0,24) (-0,79) (0,13) (-1,38) (0,36) (0,26) (-1,39) (-0,88) (0,80) Portfolio 1 -0,05% -0,0042 -0,28% -0,0020 -0,42% -0,0012 -0,03% -0,0078 -0,09% 0,0008 (-0,11) (-0,60) (-0,72) (-0,33) (-1,00) (-0,19) (-0,09) (-1,74) (-0,17) (0,10) Spread Portfolio -0,20% 0,0028 0,02% 0,0027 0,01% 0,0029 0,12% 0,0016 -0,37% 0,0056 (-0,74) (0,66) (0,07) (0,69) (0,05) (0,75) (0,52) (0,54) (-1,62) (1,61) Estimation of the four-factor model on the NAV sorted quintiles five and one and the spread portfolio (5-1) known from section 6. Returns are valueweighted. Reported are monthly alphas and coefficients on the Henriksson and Merton (1981) indicator function that equals one if the excess market return is positive and zero otherwise. For all UK funds, the sample period is 1998/1 to 2005/12. Sample periods are 2001/1 to 2004/12 for French, Italian and Spanish domestic funds and 1999/1 to 2004/12 for German domestic funds. For funds investing in Europe, sample periods range from 1996/1 to 2005/12 in France, Germany and Italy and from 1997/1 to 2005/12 in Spain. For funds investing worldwide, sample periods range from 1995/1 to 2005/12 in France, Germany and Italy and from 1996/1 to 2005/12 in Spain. Reported are OLS estimates with Newey-West Heteroskedasticity and Autocorrelation consistent (HAC) standard errors. T-values in parentheses.
Global
Portfolio 5
72
Table 7.3 Timing (Treynor and Mazuy 1966)

Panel B: Germany Panel C: Italy Panel D: Spain Panel E: UK
Panel A: France
Domestic
Portfolio 5
Portfolio 1
Spread Portfolio
Alpha -0,56% (-2,92) -1,27% (-2,96) 0,71% (1,82)
TM 0,18 (0,55) 0,51 (0,72) -0,34 (-0,52)
Alpha -0,43% (-1,80) -0,69% (-2,68) 0,26% (2,21)
TM -0,39 (-1,24) -0,04 (-0,11) -0,36 (-2,26)
Alpha -0,22% (-3,80) -0,10% (-0,95) -0,12% (-1,41)
TM 0,21 (1,86) -0,36 (-1,82) 0,57 (3,40)
Alpha -0,38% -(4,31) -0,44% -(3,64) 0,06% (0,45)
TM 0,11 (0,69) 0,26 (1,20) -0,15 (-0,68)
Alpha -0,04% (-0,28) 0,00% (-0,01) -0,03% (-0,21)
TM -0,91 (-2,53) -1,03 (-2,08) 0,12 (0,28)
Europe
Portfolio 5
Portfolio 1
Spread Portfolio
Alpha -0,04% (-0,32) -0,22% (-1,38) 0,18% (1,22)
TM -0,27 (-0,97) -0,76 (-2,01) 0,49 (1,38)
Alpha -0,19% (-1,40) -0,29% (-2,25) 0,10% (0,66)
TM 0,04 (0,12) -0,16 (-0,54) 0,20 (0,57)
Alpha -0,38% (-2,51) -0,18% (-1,32) -0,20% (-1,29)
TM 1,05 (2,99) -0,39 (-1,21) 1,44 (4,01)
Alpha -0,09% -(0,69) -0,16% -(0,98) 0,07% (0,44)
TM -0,27 (-0,96) -0,37 (-1,00) 0,09 (0,25)
Alpha 0,00% (0,01) -0,09% (-0,31) 0,09% (0,66)
TM -0,60 (-1,08) -0,23 (-0,37) -0,37 (-1,24)
Alpha TM Alpha TM Alpha TM Alpha TM Alpha TM -0,34% 0,01 -0,24% 0,05 -0,38% 0,28 -0,14% -0,51 -0,51% 1,68 (-1,52) (0,01) (-1,24) (0,10) (-2,19) (0,67) -(0,57) (-0,86) (-1,83) (2,74) Portfolio 1 -0,30% 0,01 -0,41% 0,04 -0,49% 0,02 -0,58% 0,36 -0,26% 0,85 (-1,12) (0,02) (-1,80) (0,07) (-2,02) (0,03) -(2,24) (0,61) (-0,87) (1,30) Spread Portfolio -0,04% -0,01 0,17% 0,01 0,12% 0,26 0,43% -0,87 -0,25% 0,83 (-0,26) (-0,01) (1,16) (0,03) (0,81) (0,73) (2,58) (-2,25) (-2,09) (3,12) Estimation of the four-factor model on the NAV sorted quintiles five and one and the spread portfolio (5-1) known from section 6. Returns are valueweighted. Reported are monthly alphas and coefficients on the Treynor and Mazuy (1966) market squared. For all UK funds, the sample period is 1998/1 to 2005/12. Sample periods are 2001/1 to 2004/12 for French, Italian and Spanish domestic funds and 1999/1 to 2004/12 for German domestic funds. For funds investing in Europe, sample periods range from 1996/1 to 2005/12 in France, Germany and Italy and from 1997/1 to 2005/12 in Spain. For funds investing worldwide, sample periods range from 1995/1 to 2005/12 in France, Germany and Italy and from 1996/1 to 2005/12 in Spain. Reported are OLS estimates with Newey-West Heteroskedasticity and Autocorrelation consistent (HAC) standard errors. T-values in parentheses.
Global
Portfolio 5
73
Mutual Fund Performance in Europe The Role of Fund Size Building on a study by Merton (1981), Henriksson and Merton (1981) develop a technique in order to separate micro- from macro- forecasting. Although their original model is a CAPM based one, in their 1984 study the authors explicitly suggest employing their technique in a multifactor return structure. In this study, the model is extended by the three-factor model and is specified as follows: Rit Rft = i + 0i(Rmt Rft) + TiI(Rmt Rft)+ 1iSMBt + 2iHMLt + it where I(Rmt Rft) is an indicator function that equals one if the excess market return is positive and zero otherwise. If mutual fund managers are successfully able to time the market, Ti is positive. A negative Ti indicates that the manager increased his market exposure in falling markets and vice versa. Needles to say, this should not be the managers goal. As market timing ability of mutual fund managers could bias the results obtained in section 6.1 through 6.5, it is now checked for such a bias. Results for the Henriksson and Merton (1981) specification are presented in table 7.2, while results for the Treynor and Mazuy (1966) specification are displayed in table 7.3. The two different methods for testing for timing abilities of the funds managers do not yield a consistent picture. For example, relying on the Henriksson and Merton (1981) specification, small Spanish funds investing in domestic stocks are successfully able to time the market. The coefficient on the indicator function is positive and significant. However, when estimated with the Treynor and Mazuy (1966) specification, the corresponding coefficient on the market squared factor is positive but insignificant. Depending on the model specification, significance levels relating to market timing ability are different. Therefore, a definite conclusion with respect to mutual fund managers market timing ability can not be drawn.
7.3 Survivorship Bias

Although merging the two databases is necessary in order to receive information on fund size, it comes with a loophole. Since the cross-sectional database contains live funds only, the returns presented in this study might be overstated due to survivorship bias. Therefore, this section deals with an estimation of the survivorship bias subject to the sample in use. In order to estimate the bias, the return database is used exclusively since it contains live funds as well as dead funds. In a first step, returns on live and dead funds are estimated separately in order to emphasize the performance difference between them. Secondly, equal weighted returns on the entire sample containing live as well as dead funds are
74
Mutual Fund Performance in Europe The Role of Fund Size estimated. The survivorship bias is the difference between returns on the sample including live funds and the sample containing both, live and dead funds. As depicted in table 7.4, a survivorship bias is present in all of the countries and regardless of the funds investment objective. It ranges from an annual 18 basis points for UK funds investing in Europe and the home market to 85 basis points for German funds investing with a global investment objective. Under-performance is significant for portfolios of dead, globally investing funds, while their live peers under-performance is insignificant. Although returns throughout this study are overestimated due to survivorship-bias, the qualitative implications of the study remain unchanged since large and small funds are both equally affected by the bias.
Table 7.4 Test for Survivorship Bias
Panel A: France
Domestic Europe Global

Panel B: Germany
Alpha All Funds -0,29% (-1,96) -0,14% (-1,21) -0,26% (-1,73) Alpha All Funds -0,37% (-4,10) -0,17% (-2,36) -0,29% (-1,87) Alpha All Funds 0,27% (1,91) -0,11% (-1,32) -0,26% (-1,88) Alpha All Funds -0,06% (-0,45) -0,16% (-1,98) -0,27% (-1,74)
Alpha live funds -0,24% (-1,73) -0,12% (-1,02) -0,23% (-1,51) Alpha live funds -0,33% (-3,57) -0,13% (-1,83) -0,22% (-1,53) Alpha live funds 0,30% (2,11) -0,09% (-1,21) -0,23% (-1,61) Alpha live funds 0,01% (0,06) -0,12% (-1,59) -0,25% (-1,55)
Alpha Dead Funds -0,42% (-2,45) -0,26% (-1,79) -0,34% (-2,09) Alpha Dead Funds -0,57% (-5,62) -0,37% (-4,46) -0,45% (-2,53) Alpha Dead Funds 0,20% (1,36) -0,19% (-1,66) -0,39% (-3,22) Alpha Dead Funds -0,44% (-1,89) -0,40% (-3,10) -0,42% (-2,56)
Bias (annualized) 0,56% 0,36% 0,39%

Panel C: Italy

Panel D: Spain
75

Table 7.4 Continued
Panel E: UK
Alpha All Funds Alpha live funds Alpha Dead Funds Bias (annualized) -0,23% -0,21% -0,25% 0,18% (-2,83) (-2,59) (-3,18) Europe -0,07% -0,05% -0,13% 0,18% (-0,58) (-0,45) (-1,09) Global -0,23% -0,18% -0,38% 0,63% (-1,41) (-1,09) (-2,29) Estimation of the four-factor model on all funds available from the return database. Returns are equally weighted. Reported are monthly alphas. The sample period is 1992/1 to 2006/3. Funds are classified according to country of origin and investment focus. Panel (A) reports alphas on French funds. Panel (B) reports alphas on German funds. Panel (C) reports alphas on Italian funds. Panel (D) reports alphas on Spanish funds. Panel (E) reports alphas on UK funds. Reported are OLS estimates with Newey-West Heteroskedasticity and Autocorrelation consistent (HAC) standard errors. T-values in parentheses. Domestic
7.4 Offshore Domicile

Khorona, Servaes and Tufano (2006) investigate mutual fund fees using a worldwide sample of funds. They find differences in fees between funds domiciled in offshore locations and funds domiciled elsewhere. If this is the case, then net performance differences between funds domiciled in offshore locations and other funds could be found. In this section, a test for performance differences between these two groups of funds is carried out. Funds in each country and investment objective are either allocated to the offshore portfolio or to the portfolio labelled other. The former portfolio contains funds domiciled in an offshore location while the latter portfolio contains funds domiciled in other locations. Offshore locations are Luxembourg, Dublin or any of the Channel Islands. Results are presented in table 7.5. With respect to funds investing with a European and global focus, alphas are not generally higher or smaller for funds either domiciled in an offshore location or elsewhere. In contrast, funds with a domestic investment objective perform better if domiciled domestically than when domiciled in an offshore location. This finding holds for all countries except Spain. Nevertheless, the portfolio of Spanish funds investing domestically is the smallest of all, contains only eleven funds and less than five funds over a large period of time. Therefore results for Spain have to be interpreted with caution.
76

Table 7.5 Offshore Domicile
Panel A: France Panel B: Germany
Offshore -0,34% (-3,52) -0,13% (-2,09) -0,25% (-1,42) Offshore 0,10% (0,67) -0,13% (-1,96) -0,29% (-1,68)
Other -0,31% (-1,45) -0,15% (-1,02) -0,28% (-1,67) Other 0,32% (2,26) -0,07% (-0,47) -0,20% (-2,05)
Offshore -0,44% (-4,30) -0,14% (-2,13) -0,31% (-1,74) Offshore 0,01% (0,09) -0,13% (-2,01) -0,26% (-1,43)
Other -0,34% (-3,70) -0,20% (-2,34) -0,20% (-1,75) Other -0,07% (-0,48) -0,20% (-1,40) -0,25% (-2,23)
Panel C: Italy
Panel D: Spain
Panel E: UK
Offshore Other Domestic -0,39% -0,20% (-4,79) (-2,48) Europe -0,12% -0,27% (-1,55) (-1,91) Global -0,28% -0,17% (-1,49) (-1,03) Estimation of the four-factor model on all funds available from the return database. Returns are equally weighted. Reported are monthly alphas. The sample period is 1992/1 to 2006/3. Funds are classified according to country of origin and investment focus. Panel (A) reports alphas on French funds. Panel (B) reports alphas on German funds. Panel (C) reports alphas on Italian funds. Panel (D) reports alphas on Spanish funds. Panel (E) reports alphas on UK funds. Reported are OLS estimates with Newey-West Heteroskedasticity and Autocorrelation consistent (HAC) standard errors. T-values in parentheses.
Table 7.6 exhibits spread portfolio alphas for domestically investing funds in all five countries. Returns obtained from investing in domestically domiciled funds are subtracted from returns obtained from investing in offshore funds. The spread portfolio alpha is negative and significant in France, Italy and the UK and negative but insignificant in Germany. This result shows that domestically investing mutual funds profit from their home domicile. A deeper investigation of the reasons for this finding is desirable but out of this studys scope.
Table 7.6 Offshore Domicile Domestic Spread Portfolios France Germany Italy Spain UK Domestic Spread -0,15% -0,10% -0,22% 0,08% -0,18% (-2,13) (-1,51) (-2,91) (0,65) (-3,46) Estimation of the four-factor model on all domestically investing funds available from the return database. Returns are equally weighted. Reported are monthly alphas. The sample period is 1992/1 to 2006/3. The spread portfolio is calculated by subtracting returns on funds domiciled in their home country from returns on funds domiciled in an offshore location. T-values in parentheses.
77
7.4 Active vs. Passive

The question if markets are efficient and if so, to which degree, is one of the most widely discussed topics in finance. If markets are at least semi-efficient, then all publicly available information should already be reflected in security prices. Active management is useless in such a world because no abnormal returns can be earned. A proponent of this viewpoint is J. C. Bogle who launched the first and still most popular index fund; the Vanguard 500 Index Fund. According to him, some mutual funds sometimes beat the market but not on a regular basis. Furthermore Bogle (1992) argues that the outperforming funds can not be predicted. In order to test for performance differences between active and passive equity mutual funds, funds are sorted in portfolios according to their management style (active or passive). Table 7.7 reports the results. Of the 15 portfolio pairs investigated, active management outperforms passive management in eleven cases. The unreported spread portfolio alpha for German domestically investing mutual funds is positive and significant, indicating an out performance of active funds when compared to passive funds.
Table 7.7 Active/Passive
Panel A: France Panel B: Germany
Active -0,22% (-1,62) -0,11% (-1,06) -0,25% (-1,59) Active n/a n/a -0,09% (-1,08) -0,31% (-2,21)
Passive -0,28% (-1,44) -0,20% (-1,08) -0,12% (-0,51)

Panel C: Italy
Active -0,37% (-4,08) -0,12% (-1,72) -0,22% (-1,47) Active 0,01% (0,08) -0,13% (-1,67) -0,25% (-1,54)
Passive -0,54% (-4,93) -0,19% (-2,68) -0,29% (-1,61) Passive -0,20% (-1,47) -0,11% (-1,03) -0,38% (-2,06)
Panel D: Spain
Passive n/a n/a -0,24% (-1,70) -0,43% (-2,70)

Panel E: UK
Active Passive -0,14% -0,18% (-1,89) (-2,53) Europe 0,05% -0,02% (0,38) (-0,14) Global -0,10% -0,20% (-0,58) (-1,07) Estimation of the four-factor model on all funds available from the return database. Returns are equally weighted. Reported are monthly alphas. The sample period is 1992/1 to 2006/3. Funds are classified according to country of origin and investment focus. Panel (A) reports alphas on French funds. Panel (B) reports alphas on German funds. Panel (C) reports alphas on Italian funds. Panel (D) reports alphas on Spanish funds. Panel (E) reports alphas on UK funds. Reported are OLS estimates with Newey-West Heteroskedasticity and Autocorrelation consistent (HAC) standard errors. T-values in parentheses. Domestic
78
8 Conclusion
This thesis investigates the effects of equity mutual fund size on performance in France, Germany, Italy, Spain and the UK. Although still much smaller than the US mutual fund market, the European mutual fund market exhibits continuous growth in assets under management since the year 2002. Moreover, the European market gained a substantial portion of the worldwide mutual fund market at the expense of the US market. To put this into perspective, European mutual funds net asset volume today accounts for almost 60 per cent when measured in relation to EU-GDP. Since the UCITS directive was passed by the EU in 1985, funds are much more easily distributed over all EU countries. This has accelerated the growth in assets under management of European mutual funds and augmented the importance of Luxembourg as Europes major mutual fund domicile. Not only the fund market as a whole is growing, also the individual funds for purchase in Europe are getting larger. While in 1995 the median European equity mutual fund had a net asset volume of roughly 35 million, the same number increased to about 250 million in 2005. The largest funds for purchase are mostly multinationally distributed, globally investing funds of large fund families like Fidelity or Franklin Templeton. Performance differences between small and large European funds are analyzed utilizing a merged dataset consisting of a return dataset and a dataset on cross-sectional fund characteristics. After a yearly rebalancing of the five NAV sorted quintile portfolios, risk-adjusted returns are obtained using the one-factor as well as the three- and four factor model. Most attention is drawn to the so-called spread portfolios which are obtained by subtracting the returns of the quintile portfolio containing the smallest funds from the returns on the quintile portfolio containing the largest funds. In all, 15 spread portfolios are calculated resulting from an investigation of three different geographical investment focuses (Domestic, Europe and Global) in the five investigated European countries. In the continental European countries, ten of the twelve spread portfolio alphas are positive. All spread portfolio alphas for UK funds are negative. Nevertheless, most of these results are not supported by the appropriate significance levels. The only significant spread portfolio alpha is obtained for French funds investing with a European investment focus. Concentrating on more extremely sized portfolios has a negligible effect on the results. As the so-called liquidity hypothesis implies a somewhat stronger eroding effect of fund size on performance for funds investing in small cap stocks, it is tested whether the hypothesis is confirmed by the data. Apart from the French market, the results indicate that 79
Mutual Fund Performance in Europe The Role of Fund Size large small cap funds perform worse than small ones. Although this is in line with the liquidity hypothesis, the results lack appropriate significance levels. Checking for performance differentials between funds located domestically and those located in offshore domiciles reveals an astonishing result. If the Spanish market is left aside because results suffer from a lack of funds and observations, results offer a consistent picture throughout all investigated countries. Domestically investing funds domiciled in their country of origin out-perform their offshore domiciled funds on a riskadjusted basis. Apart from the German market, these results are supported by appropriate significance levels. However, the results should be treated with caution since some portfolios on which the analysis is based only contain a small number of funds. Furthermore, as a deeper investigation of the reasons for this finding is out of this studys scope, it is not provided for a qualitative explanation of these results. With respect to investment preferences of small and large equity mutual funds, the funds loadings on the factors incorporated in the four-factor model reveal a correlation between fund size and investment target. Throughout most countries and geographical investment objectives, small funds load to a larger extent on SMB than large funds do. This indicates that small funds prefer smaller targets while large funds primarily invest in larger firms. Liquidity considerations referred to throughout this study might be the reason for this finding. Furthermore, small French, German and Italian domestically investing funds have a higher exposure to the market than larger funds. They seem to invest in riskier stocks than large ones if market risk is the risk measure. For an individual investor intending to buy equity mutual funds in one of the European countries, the following recommendations can be derived from what is found in this study: Buy larger funds since they perform better than small ones (unless the investor lives in the UK, where the opposite is true). When considering the purchase of small cap funds, buy smaller funds and perhaps move out when the fund has grown too large. When considering the purchase of domestically investing funds, buy funds that are domiciled in the country of purchase, not in offshore locations (to be treated with caution).
80
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Mutual Fund Performance in Europe The Role of Fund Size Dermine, H. & Rller, L.-H. (1992). Economies of Scale and Scope in French Mutual Funds. Journal of Financial Intermediation, 2, 83-93. Droms, W. & Walker, D. (1994). Investment Performance of International Mutual Funds. Journal of Financial Research, 27, 1-14. Fama, E.F. & French, K. R. (1993). Common Risk Factors in the Returns on Stocks and Bonds. Journal of Financial Economics, 33(1), 3-56 Fletcher, J. & Marshall, A. (2005): The Performance of UK International Unit Trusts. European Financial Management, 11, 365-386. Friend, I.., Blume, M. & Crockett, J. Mutual Funds and Other Institutional Investors. (New York: Mc Graw Hill, 1970). Goetzmann, W. N., & Ibbotson, R. G. (1994). Do Winners Repeat? Journal of Portfolio Management, 20(2), 9-18. Grinblatt, M. & Titman, S. (1989). Mutual Fund Performance: An Analysis of Quarterly portfolio Holdings. The Journal of Business, 62(3), 313-416. Grinblatt, M. & Titman, S. (1989). A Study of Monthly Fund returns and Performance Evaluation Techniques. Journal of Financial and Quantitative Analysis, 29, 419-444. Gruber, M. J. (1996). Another Puzzle: The Growth in Actively Managed Mutual Funds. Journal of Finance, 51(3), 783-810. Grnbichler, A. & Pleschiutschnig, U. (1999). Performance Persistence: Evidence for the European Mutual Fund Market. Working Paper. University of St. Gallen. Hendricks D., Patel, J. & Zeckhauser, R. (1993): Hot Hands in Mutual Funds: Short-Run Persistence of Relative Performance, 1974-1988. Journal of Finance, 48(1), 93-130. Henriksson, R. D. & Merton, R. C. (1981). On Market Timing and Investment Performance. Statistical Procedures for Evaluating Forecasting Skills. Journal of Business, 54(4), 513-533 Henriksson, R. D. (1984). Market Timing and mutual Fund Performance: Am Empirical Investigation. The Journal of Business, 57(1), 73-96. Indro, D., Jiang, C., Hu, M. & Lee, W. (1999). Mutual Fund Performance: Does Fund Size Matter? Financial Analysts Journal, 55, 74-87 Ippolito, R. A. (1989). Efficiency With Costly Information: A Study of Mutual Fund Performance, 1965-1984. The Quarterly Journal of Economics, 104(1), 1-23. Jensen, M. C. (1968). The Performance of Mutual Funds in the period 1945-1964. Journal of Finance, 32(2), 389-416. Jensen, M. C. (1972). Capital and Markets: Theory and Evidence. The Bell Journal of Economics and Management Science, 3(2), 357-398 82
Mutual Fund Performance in Europe The Role of Fund Size Khorona, A., Servaes, H. & Tufano, P. (2006). Mutual Fund Fees Around the World. Working Paper. Georgia Institute of Technology Krahnen, J. P., Schmidt. F. A. & Theissen, E. (1997). Performance and Market Share: Evidence from the German Mutual Fund Industry, Working Paper, centre for financial studies, Frankfurt/Main. Lintner, J. (1965). Security Prices, Risk, and Maximal Gains from Diversification. Journal of Finance, 20, 587-616. Malkiel, B. G. (1995). Returns from Investing in Equity Mutual Funds 1971 to 1991. Journal of Finance, 50(2), 549-572. Merton, R. C. (1981). On Market Timing and Investment Performance. I. An Equilibrium Theory of Value for Market Forecasts. , Journal of Business, 54, 363-406 Mc Donald, J. (1973). French Mutual Fund Performance: Evaluation of Internationally diversified portfolios. Journal of Finance, 28, 1161-1180. Nocera, J. (1996). Time to Bail Out of the Magellan Fund? Fortune, 133(5), 128-129 Perold, A. & Salomon, R. S. (1991). The Right Amount of Assets under Management. Financial Analysts Journal, 47(3), 31-39 Sainz, J., Grau, P. & Doncel, L. M.. (2006): Mutual Fund Performance and Benchmark Choice: The Spanish Case. Applied Financial economic Letters, 2, 317-321 Sharpe, W. F. (1964). Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk. Journal of Finance, 19, 425-442. Sharpe, W. F. (1966). Mutual Fund Performance. Journal of Business, 39, 119-138. Smith, G. (1994). Inside Fidelity: How the Fund Giants Stock Picking Machine Works. Business Week, October 10th, 88 Stotz, O. (2007). Selection, Market Timing and Style Timing of Equity Mutual Funds: Evidence from Germany. Zeitschrift fr Betriebswirtschaftslehre, 77, 51-73 Treynor, J. & Mazuy, K. (1966). Can Mutual Fund Managers Outguess the Market? Harvard Business Review, 44, 131-136 Vicente, L. & Ferruz, L. (2005). Performance Persistence in Spanish Equity Funds. Applied Financial Economics, 15, 1305-1313. Wermers, R. (2000). Mutual Fund Performance: An Empirical Decomposition into StockPicking Talent, Style, Transaction Costs, and Expenses. Journal of Finance, 55(4), 1655-1695.
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Master Thesis

Mutual Fund Performance in Europe The Role of Fund Size

Moritz Felde ID 444650

Supervisor: Dr. Rogr Otten

Mutual Fund Performance in Europe The Role of Fund Size

Mutual Fund Performance in Europe The Role of Fund Size

Mutual Fund Performance in Europe The Role of Fund Size

Mutual Fund Performance in Europe The Role of Fund Size

Mutual Fund Performance in Europe The Role of Fund Size

2.1 US Mutual Funds

2.2 European Mutual Funds

2.3 Fund Size

Mutual Fund Performance in Europe The Role of Fund Size

3 The Mutual Fund Market

Africa and Asia Pacific 12%

Other Americas 5% United States 48%

3.1 The French Mutual Fund Market

3.2 The German Mutual Fund Market

3.3 The Italian Mutual Fund Market

Mutual Fund Performance in Europe The Role of Fund Size

3.4 The Spanish Mutual Fund Market

3.5 The UK Mutual Fund Market

Mutual Fund Performance in Europe The Role of Fund Size

Mutual Fund Performance in Europe The Role of Fund Size

Mutual Fund Performance in Europe The Role of Fund Size

Mutual Fund Performance in Europe The Role of Fund Size

Mutual Fund Performance in Europe The Role of Fund Size

Mutual Fund Performance in Europe The Role of Fund Size

5.2 Performance Measurement

5.3 Portfolio Formation

Mutual Fund Performance in Europe The Role of Fund Size

6 Time Series Analysis

6.1 The effect of fund size in France

Portfolio 5 (large) 4 3 2 1 (small) 5-1 Spread

Monthly Excess Return -0,97% -0,87% -0,88% -0,94% -1,31% 0,34%

Std Dev 5,71% 5,80% 5,89% 6,16% 7,26% 2,78%

Adj R-Squared 0,96 0,95 0,96 0,93 0,83 0,12

Panel B: Three-Factor Model

Portfolio 5 (large) 4 3 2 1 (small) 5-1 Spread

Adj R-Squared 0,97 0,98 0,98 0,97 0,90 0,45

Panel C: Four-Factor Model

Portfolio 5 (large) 4 3 2 1 (small) 5-1 Spread

Monthly Excess Return 0,67% 0,62% 0,59% 0,46% 0,42% 0,24%

Std Dev 5,32% 5,10% 5,25% 5,11% 5,28% 1,31%

Adj R-Squared 0,96 0,97 0,95 0,96 0,93 0,00

Panel B: Three-Factor Model

Portfolio 5 (large) 4 3 2 1 (small) 5-1 Spread

Adj R-Squared 0,97 0,98 0,97 0,96 0,94 0,10

Panel C: Four-Factor Model

Portfolio 5 (large) 4 3 2 1 (small) 5-1 Spread

Monthly Excess Return 0,06% 0,10% 0,25% 0,17% 0,12% -0,07%

Std Dev 5,69% 5,49% 5,31% 5,21% 5,07% 1,87%

Adj R-Squared 0,79 0,77 0,77 0,76 0,73 0,15

Panel B: Three-Factor Model

Portfolio 5 (large) 4 3 2 1 (small) 5-1 Spread

Adj R-Squared 0,87 0,84 0,82 0,81 0,77 0,38

Mutual Fund Performance in Europe The Role of Fund Size

6.2 The effect of fund size in Germany

Mutual Fund Performance in Europe The Role of Fund Size

Portfolio 5 (large) 4 3 2 1 (small) 5-1 Spread

Monthly Excess Return -0,44% -0,44% -0,43% -0,28% -0,58% 0,15%

Std Dev 7,16% 7,10% 6,95% 6,51% 6,92% 1,31%

Adj R-Squared 0,93 0,94 0,93 0,94 0,91 0,03

Panel B: Three-Factor Model