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CHAPTER 2

REVIEW OF LITERATURE

2.1 INTRODUCTION

Review of literature provides the way for a clear understanding of

the existing research and gives an idea about research areas which are yet to
be explored. Keeping this view in mind, an attempt has been made to make a
brief survey of works undertaken in the field of risk and return of mutual
funds.

This chapter deals with the review of literatures concerned with the
subject of this study. Many studies have been conducted by many experts and
researchers in the world on risk and return of mutual funds. The reviews of
some of the studies are presented in this chapter.

Mutual funds have already attracted the attention of global

practitioners and academicians and they have analysed and evaluated the
performance of portfolio, which considers return and risk of the investment. It
was pioneered by Treynor (1965), Sharpe (1966) and Jensen (1968). There
are also other studies that focus on investors’ objective and their risk- taking
capacity. The studies already made by the researchers are reviewed and given
in this chapter. These studies have been categorized as studies related to Risk-
Return Trade-Off and studies related to Investors’ behavior.
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2.2 STUDIES ALREADY CONDUCTED RELATED TO RISK-

RETURN TRADE OFF

Investors are generally more careful while making investment

decisions and demand higher return at minimum risk. They may also use
various measures to predict the return and risk on their investment. Literature
regarding investment, risk and return are reviewed here.

William Sharpe (1966), made an attempt to measure and predicts

the performance of mutual funds by a simple measure like average return and
risk and he identified the fact that good performance of funds is associated
with low expense ratio.

Frohlich (1991), examined the performance of a sample each of

bond, stock and balanced funds and identified that no mutual funds in the
selected category has outperformed the market. He also added that fund
managers are could not able to predict the security prices regularly to
guarantee the associated costs.

Eugene Fama and Kenneth French (1992), identified five

common risk factors in the returns on stock and bonds. Among the five, three
factors are related to stock market namely, overall market, firm size and book-
to-market equity. The other two factors related to bond-market are maturity
and default risks. Stock returns are linked to both stock market factors and
bond market returns.

John Sorros (2003), evaluated the risk and return of 16 equity

Mutual funds operating in the Greek Financial market over the period from
1995 to 1999. In this paper the author used Treasury bills as risk-free rate of
return and they used Daily return, Standard Deviation, Coefficient of
Variation, Beta Coefficient, Sharpe and Treynor for evaluating the risk and
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return of mutual funds. The study revealed that all the sixteen mutual funds
showed that total risk and risk-return coefficient are lower than the General
Index of the Athens Stock Exchange (ASE) and there was a variation in return
in all the sixteen mutual funds.

Roger Otten and Dennis Bams (2004), tried to address the most
appropriate model to determine the mutual fund performance. The author
used US mutual funds for his research and used one month Treasury bill as
risk free rate of return. They used conditional and unconditional model of
Capital Asset Pricing Model (CAPM), Fama and French models. They found
that conditional models have strong economic relevance which helps the
investor to detect the patterns in the US mutual fund.

Joseph Chen et al (2004), analysed U.S diversified mutual funds

for the period from 1962 to 1999 by using monthly returns. The author used
Standard Deviation, Capital Asset Pricing Model of William F. Sharpe,
Eugene F. Fama and Keneeth R. French three-factor model for the analysis.
One month Treasury bill return was considered by the author for risk free rate
of return. It has been found that these funds’ family size does not significantly
erode the performance of this fund.

Marcin Kapcperczyk et al (2006), analysed the impact of

unobserved actions on fund performance using United States equity mutual
funds during the period between 1984 and 2003. The author estimated the
unobserved actions by taking the difference between the investor returns and
the buy-and-hold returns. The difference between these two is important for
predicting performance of fund and for identifying funds with negative
unobserved actions that negatively affect the investor returns.

Romachi and Cortez (2006), analysed the mutual funds of

Portugues, European and International equity in order to exhibit the timing
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and selectivity skills of their fund managers. The study found that the timing
ability of the fund managers is not efficient and that volatility exists in the
returns of Portugal mutual funds.

Hossein Varamini Svetlana Kalash (2008), made a study to

analyse the Efficient Market Hypothesis for different market capitalization
and investment styles of mutual funds for the period of 1994-2007. The study
results indicated that small cap funds have provided the highest risk-adjusted
return for the entire period whereas growth funds have exhibited lower
returns. The author also found that the mutual funds market is not always
efficient and this inefficiency makes it possible for an investor or a mutual
fund manager to earn excess return on the risk-adjusted basis.

Madhumita Chakraborty et al (2008), evaluated the performance

of randomly selected 40 mutual funds over a period of three years from 2005
to 2007 based on rate of return as well as the risk-adjusted methods. The
study found that all the equity mutual funds earned excess return compared to
the risk-free rate of return offered by 364-day Treasury bill for the period
2005-07. It was also found that all the funds outperformed the market
benchmark.

Malek Lashgari (2008), examined mutual funds and developed a

performance tracking criterion consistent with Sharpe ratio. The author has
stated that Alpha, Beta and Treynor’s measures are informative indicators of
the risk adjusted performance; he has also stated that investors typically
compare their returns with a popular benchmark.

Viviane Naimy (2008), compared the return of eight different

United States equity funds with the New York Stock Exchange Composite
Index for the period of 2000-2007 and found that both the returns are
relatively moving together. The author also warned that investors need to be
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aware of problems and issues of mutual funds and have to reconsider other
investment alternatives for better returns.

Beehary Nitish et al (2009), analysed the performance of seven

Mauritian mutual fund schemes for five years that is from 2000 to 2005 and
found that there was a balance in capital allocation between stocks, bonds and
cash because, Beta is lower than 1 and the Alpha is positive. So the fund
manager’s skill improves in stock picking. These fund schemes have beaten
the market and the funds heavily depend on the performance of local stock
market.

John Cresson (2009), analysed forty two S&P 500 mutual funds
and found that systematic risk measures from daily returns were very close to
one, varied across funds and were not statistically different from systematic
risk measures based on monthly returns.

Kavitha Chavali and Shefali Jain (2009), evaluated the

performance of 16 equity-linked savings schemes using their risk and return
and compared their performance with its benchmark S&P CNX Nifty. It has
been found that majority of the investors were aware of the mutual funds,
their risk and return proportion.

Mukhopadhyay and Veena Viswanathan (2009), examined

whether mutual funds could actually impart more value than the stock market
and protect the interests of the investors during the downturn. The study
found that during the sharp downturn the schemes not only gave negative
returns but also underperformed the market index.

Zakri Bello (2009), examined five factors namely default risk

premium, term premium, monetary conditions, federal fund premium and
market risk premium and confirms that mutual fund returns can be strongly
predicted by analyzing these factors.
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Hojatallah Goudarzi and Ramanarayanan, CS (2010), examined

Indian stock markets volatility and its related stylized facts using ARCH
models. The author used daily return of BSE 500 stock index over a period of
10 years from 2000 to 2009. The study results revealed that the GARCH
model appropriately explains volatility of Indian stock market.

Keith Cuthbertson et al (2010), anlysed U.S and U.K- managed

and index mutual funds by using Sharpe, Alpha and Fama-French three factor
model. The author concluded that there are a few funds that existed with little
winner persistence but more number of funds loss will persist.

Majid Rahmani Firozjaee and Zeinab Salmani Jelodar (2010),

compared CAPM and Fama and French three factor model and examined the
power of market, size, and book to market ratio which influence the return of
stocks. The authors concluded that Fama and French model have strong
explanatory power than CAPM.

Ahmed Elsheikh Ahmed, M and Suliman Zakaria (2011), used

GARCH model to estimate volatility of Khartoum Stock Exchange, Sudan
over the period from January 2006 to November 2010. Daily returns of the
stock exchange has been taken for the purpose of the study and found that
high volatility of index return series is present in Sudanese Stock Market over
the sample period.

2.3 STUDIES ALREADY CONDUCTED RELATED TO

INVESTORS’ BEHAVIOUR

Gordon Alexander et al (1997), analysed the various

characteristics and investment knowledge of investors and found that the
investors are knowledgeable about costs, risk and returns associated with
mutual funds.
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Thomas Feuerborn (2001), argued that the individual investor will

continue to be misled by mutual fund companies that market new funds.
There, no one is taking the completely honest approach that consumers can
trust.

According to the Joint Parliamentary committee Report on Stock

Market Scam 2003, regulatory authorities like Securities and Exchange Board
of India (SEBI), Reserve Bank of India (RBI) and Department of Company
Affairs (DCA) should be able to lay down and implement guidelines and
procedures that could prevent scam or at least activate red alerts that could
lead to early finding, investigation and action against misleading mutual fund
companies for rectification of any discovered systematic deficiencies.
Followed by this, SEBI has taken various steps to tone up the administration
of stock exchanges such as debarring the broker members from holding the
top level positions like president, vice president and treasurer.

Dengpan Luo (2003), studied the relation between asset allocation

decisions of mutual fund investors’ and changes in business conditions. The
study found that changes of real macroeconomic activities have strong impact
on mutual fund investors’ allocations between stocks and bonds.

Ronald Wilcox (2003), examined how investors choose a mutual

fund and found that investors pay a great attention to past performance. He
also indicated that the educated investors who demonstrated greater
knowledge of basic finance made decisions poorer than their less financially
savvy.

Susan Coleman (2003), examined the attitude of investors towards

risk and holding of risky assets of black, white and Hispanic households using
data from the 1998 survey of Consumer Finances. The result showed that
Hispanic heads of households were more risk averse and they are unwilling to
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take any risk in exchange for investment returns. Black and white households
are not more risk averse even though there is different asset mix. The study
has also found that women and older heads of households express a higher
degree of risk aversion and hold a lower percentage of risky assets. Similarly,
it was found that more highly-educated individuals and wealthier heads of
households express a lower degree of risk aversion and hold a higher
percentage of risky assets.

Mehru (2004), documented that the ignorance of the mutual fund

investors’ attached with aggressive selling by promising higher returns given
by the agents, have resulted in the loss of investors’ confidence due to
inability to provide higher return. The agents or distributors of mutual funds
are more concerned by the commissions and incentives they get for selling the
schemes. They are not bothering the requirements of the investors and quality
of the products and they do not explain the risk factors associated with mutual
funds to the investors.

Paula Tkac (2004), found that investors were irrational or in some

other sense cannot look out for their own best interests. Mutual fund industry
provides a variety of products and price structures to heterogeneous consumer
preferences and budgets. Consumer who prefer more style, features or power
of funds, willingly pays higher prices and the investor relay on the financial
advisors or brokers for processing and formulating guidance regarding fund
allocation. So, they are facing risk because of misconduct by the advisory
firms and they are not demanding any disclosures of their fund. The risks
were reduced to zero if investors are willing to pay with their own time and
energy to monitor their fund position.

Athanasious Noulas et al (2005), evaluated the performance of 23

equity funds for the period from 1997 to 2000 in Greece. The author
evaluated the performance based on measuring risk and return of the selected
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funds. The study proved that the investors are very much needed, to know the
long term behaviour of Mutual funds. So that, they can make the right
investment decision.

Allison Evans (2008), analysed the relationship between mutual

fund manager’s personal fund investment and mutual fund performance. The
author found that managerial ownership is inversely related to fund turnover.

Onur Arugaslam et al (2008), noted that better investment

strategy enables investors to earn superior return for an average level of risk.
An investor, who is comfortable with high level risk, could have attained
higher returns.

Umaya Salma Shajahan and Archana (2008), found that

investors prefer high rate of returns in mutual fund and there is an association
between investment and annual income of the investors.

Duguleana et al (2009), evaluated the performance of mutual

funds by taking a look at the timing and selection abilities of a portfolio
managers and found that the fund manager has market timing ability.

Laurens Swinkels (2009), analysed 38 mutual funds over the

period from 2000 to 2007. The author investigated the manager’s selectivity
and market timing skills and found that mutual fund managers do not perform
worse and have different selectivity skills to perform better and beat the
market.

Parihar et al (2009), analysed attitude of 200 mutual funds

investors and he revealed that majority of investors have not formed any
attitude towards mutual fund investments.
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Phaniswara Raju and Mallikarjuna Rao (2009), found that

private sector scheme managers are better performers than the managers of
public sector schemes in their macro market timing ability.

Rajesh Kothari and Narendra Sharma (2009), explored

Parasuraman's 5 dimensions of service quality for mutual funds in India. The
author identified that investors had high familiarity of corporate brand in
mutual fund industry in India which is more influential than any other factor.
Increasing investors’ awareness could help in better recall and add value
towards perceived service quality for mutual funds in India.

Ravi Kiran (2009), highlighted the volatility which is influencing

stock market movements. The author revealed that mutual funds are most
preferred financial avenues but needs some innovation and added quality
dimensions in existing services.

Sebastian Muller and Martin Weber (2010), constructed an

objective of financial literacy score and analysed the relation between
financial literacy and mutual fund investment behaviour. For the purpose of
analysis the author collected the data through internet survey in cooperation
with a large German newspaper. More than 3,000 mutual fund investors with
a wide range of variation in the level of financial literacy were the
respondents in the study. The research result showed that there was a positive
influence of financial literacy on the likelihood of investing in low-cost fund
alternatives.

2.4 CONCLUDING REMARKS

The studies reviewed, have concentrated on the investors’

behaviour on various types of mutual fund schemes. The study reviews,
related to Risk-Return Trade-Off shows, that many of the authors evaluated
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the risk and return of mutual fund performance using measures like Standard
Deviation, GARCH, TARCH, Sharpe, Treynor, Jensen’s Alpha and Beta. The
study reviews, related to Investors’ Behaviour towards risk and return of
mutual funds, show that many contributions have offered in different
perspectives of investors’ behaviour worldwide and explained many
variables, models and analyzing tools. The major factors considered in this
study review are investors’ knowledge, awareness, investment decision, past
performance, risk-taking ability and satisfaction.

From the outcome of these studies, it could be understood that they

have not addressed the following factors with respect to investors’ behaviour
on risk and return of Tax Saving Mutual Fund Schemes such as

i) Factors considered by investors.

ii) Methods used to understand risk and return on investment and
iii) Investors’ grievances.

An attempt has been made in this study to address the above

mentioned issues and also an attempt has been made to analyse risk and return
of all the growth-oriented Tax Saving Mutual Fund Schemes in India using
the models already employed in the studies reviewed. The study also used
required relevant variables, models and tools already employed in the study
reviews.