Mutual Fund Risk & Return

Mahindra & Mahindra Financial Services Limited
A summer training report on
“the knowledge of Risk Tolerance that an Investor can handle

to find an optimal trade-off between the risk and returns”
(05 May 2008 – 05 Juy 2008)
Under the Guidance of
Mr. TARUN KUMAR SINGH Mr. PRASHANT DUTTA GUPTA

(INDUSTRY GUIDE) (FACULTY GUIDE)
By
MANISH PRASAD
Roll no: 27090

Batch: 2007-09
NIILM CENTRE FOR MANAGEMENT STUDIES

NEW DELHI.
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INFORMATION SHEET
1) NAME OF THE COMPANY: Mahindra & Mahindra Financial

Services Limited
2) ADDRESS OF THE COMPANY: M-8, 2nd Floor, Old DLF Colony,

Sector-14, GURGAON-121003
3) PHONE NUMBER OF THE COMPANY: 022- 66526000
4) DATE OF INTERNSHIP COMMENCEMENT: 05/05/2008
5) DATE OF INTERNSHIP COMPLETETION: 50/07/2008
6) SIGATURE AND NAME OF THE INDUSTRY GUIDE: -------------------------

Mr. TARUN KUMAR SINGH
7) DESIGNATION OF THE INDUSTRY GUIDE: “Customer Relationship manager”
8) STUDENT’S NAME: Manish Prasad
9) STUDENT’S ROLL NUMBER: 27090
10) STUDENT’S EMAIL ID: pmanish2001@gmail.com
11) STUDENT’S MOBILE/RESIDENCE NUMBERS: 9871936904/03412240836
NIILM- CENTRE FOR MANAGEMENT STUDIES

B-II/66, M.C.I.E., Sher Shah Suri Marg, New Delhi- 110044. Tel: (011) 29894514.
3
CERTIFICATE OF AUTHENTICITY
This is to certify that MR. MANISH PRASAD student of PGDBM (Full Time) 2007-
2009 batch, NIILM – Centre for Management Studies, NEW DELHI, has done his
training project under my supervision and guidance.
During his project he was found to be very sincere and attentive to small details
whatsoever was told to him.
I wish him good luck and success in his future
…………………………… ……………………………
(Manish Prasad) ( Mr. Prashant Dutta Gupta)
27090 Professor

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ACKNOWLEDGEMENT
It is a pleasure to acknowledge my mentors, friends and respondents, though it is still

inadequate appreciation for their contribution.
I would not have completed this journey without the help, guidance and
support of certain people who acted as guides, friends and torchbearers along the
way.
I would like to express my deepest and sincere thanks to my company guide

Mr. Tarun Kumar Singh , Customer Relationship manager, Ashutosh pankaj of
Mahindra & Mahindra Financial Services Limited. and my faculty guide Mr.
Prashant Dutta Gupta for their valuable guidance and help. The project could not be
complete without their support and guidance. Thanking them is only a small gesture
for the generosity shown.
I am also thankful to all my friends, my family and all the staff members of
Mahindra & Mahindra Financial Services Limited , for cooperating with me at every
stage of the project. They acted as a continuous source of inspiration and
motivated me throughout the duration of the project helping me a lot in
completing this project.
Manish Prasad
27090
Niilm-Cms

5
ABSTRACT
A Mutual Fund is the most suitable investment for the common man as it offers an
opportunity to invest in a diversified, professionally managed basket of securities at a
relatively low cost.
In finance theory, investment risk is considered a precise, abstract and purely technical
statistical concept. This risk concept, however, does not reflect private investors’
understanding of risk; they have a more intuitive, less quantitative, rather emotionally
driven risk perception. Empirical studies that deal with investors’ risk perceptions
detect four different dimensions of perceived risk:
— Downside risk: the perceived risk of suffering financial losses due to negative
deviations of returns, starting from an individual reference point
— Upside risk: the perceived chance of realising higher-than-average returns,
starting from an individual reference point
— Volatility: the perceived fluctuations of returns over time
Ambiguity: a subjective feeling of uncertainty due to lack of information and lack of
competence.
Consumers wishing to avoid risk do not buy mutual funds, since risk is inherent in all
stock market products. Consumers may however try to minimize risks.
Consumers take a big risk when they invest money in the stock market as opposed to
traditional bank deposits or bonds. Consequently, they are willing to take that risk to
get a higher return than they would get from traditional savings.
Since no prior Consumer Behaviour studies with a holistic focus on the mutual
fund market were available, all Likert-scales had to be developed for this study.
Most consumers buy mutual funds as a means to some other goal (retirement, house,
vacation, etc.). Thus, they do not consume mutual funds in the same sense that other
products and services are consumed.

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CONTENTS
Information Sheet…………………………………………………………………………….2
Acknowledgement …………………………………………………………………………. 4
Abstract…………...………………………………………………………………………….. 5
Chapter 1 Introduction 7
About Mutual Fund Industry 8
About Mahindra & Mahindra Financial Services Limited 14
Chapter 2 Review of Literature 17

Advertising in the mutual fund business 18
Risk- Return Perceptions and Advertising Content 20
Consumer Knowledge, Involvement, and Risk Willingness on Investments 24
Return and Risk on Common Stocks 33
Idiosyncratic Risk and Mutual Fund Return 36
Chapter 3 Methodology 38
BETA, Risk and Mutual Funds 46
Data: NAVs of mutual fund schemes 53
Fund analysis 59
Chapter 4 Research Analysis and Conclusion 79
Bibliography 84
References
Annexure
-Questionnaire

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CHAPTER 1
INTRODUCTION

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ABOUT MUTUAL FUND INDUSTRY
CONCEPT
A Mutual Fund is a trust that pools the savings of a number of investors who share a
common financial goal. The money thus collected is then invested in capital market
instruments such as shares, debentures and other securities. The income earned
through these investments and the capital appreciation realised are shared by its unit
holders in proportion to the number of units owned by them. Thus a Mutual Fund is
the most suitable investment for the common man as it offers an opportunity to invest
in a diversified, professionally managed basket of securities at a relatively low cost.
The flow chart below describes broadly the working of a mutual fund:
Fig. Mutual Fund Operation Flow Chart

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ORGANISATION OF A MUTUAL FUND
There are many entities involved and the diagram below illustrates the organisational
set up of a mutual fund:
Fig. Organisation of a Mutual Fund
ADVANTAGES OF MUTUAL FUNDS
The advantages of investing in a Mutual Fund are:

Professional Management
Diversification
Convenient Administration
Return Potential
Low Costs
Liquidity
Transparency
Flexibility
Choice of schemes
Tax benefits
Well regulated
TYPES OF MUTUAL FUND SCHEMES

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Wide variety of Mutual Fund Schemes exists to cater to the needs such as financial
position, risk tolerance and return expectations etc. The table below gives an overview
into the existing types of schemes in the Industry.
History of the Indian Mutual Fund Industry
The mutual fund industry in India started in 1963 with the formation of Unit Trust of
India, at the initiative of the Government of India and Reserve Bank the. The history
of mutual funds in India can be broadly divided into four distinct phases
First Phase – 1964-87
Unit Trust of India (UTI) was established on 1963 by an Act of Parliament. It was set
up by the Reserve Bank of India and functioned under the Regulatory and
administrative control of the Reserve Bank of India. In 1978 UTI was de-linked from
the RBI and the Industrial Development Bank of India (IDBI) took over the
regulatory and administrative control in place of RBI. The first scheme launched by

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UTI was Unit Scheme 1964. At the end of 1988 UTI had Rs.6,700 crores of assets
under management.
Second Phase – 1987-1993 (Entry of Public Sector Funds)
1987 marked the entry of non- UTI, public sector mutual funds set up by public sector
banks and Life Insurance Corporation of India (LIC) and General Insurance
Corporation of India (GIC). SBI Mutual Fund was the first non- UTI Mutual Fund
established in June 1987 followed by Canbank Mutual Fund (Dec 87), Punjab
National Bank Mutual Fund (Aug 89), Indian Bank Mutual Fund (Nov 89), Bank of
India (Jun 90), Bank of Baroda Mutual Fund (Oct 92). LIC established its mutual
fund in June 1989 while GIC had set up its mutual fund in December 1990.
At the end of 1993, the mutual fund industry had assets under management of
Rs.47,004 crores.
Third Phase – 1993-2003 (Entry of Private Sector Funds)
With the entry of private sector funds in 1993, a new era started in the Indian mutual
fund industry, giving the Indian investors a wider choice of fund families. Also, 1993
was the year in which the first Mutual Fund Regulations came into being, under
which all mutual funds, except UTI were to be registered and governed. The erstwhile
Kothari Pioneer (now merged with Franklin Templeton) was the first private sector
mutual fund registered in July 1993.
The 1993 SEBI (Mutual Fund) Regulations were substituted by a more

comprehensive and revised Mutual Fund Regulations in 1996. The industry now
functions under the SEBI (Mutual Fund) Regulations 1996.
The number of mutual fund houses went on increasing, with many foreign mutual
funds setting up funds in India and also the industry has witnessed several mergers
and acquisitions. As at the end of January 2003, there were 33 mutual funds with total
assets of Rs. 1,21,805 crores. The Unit Trust of India with Rs.44,541 crores of assets
under management was way ahead of other mutual funds.

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Fourth Phase – since February 2003
In February 2003, following the repeal of the Unit Trust of India Act 1963 UTI was
bifurcated into two separate entities. One is the Specified Undertaking of the Unit
Trust of India with assets under management of Rs.29,835 crores as at the end of
January 2003, representing broadly, the assets of US 64 scheme, assured return and
certain other schemes. The Specified Undertaking of Unit Trust of India, functioning
under an administrator and under the rules framed by Government of India and does
not come under the purview of the Mutual Fund Regulations.
The second is the UTI Mutual Fund Ltd, sponsored by SBI, PNB, BOB and LIC. It is
registered with SEBI and functions under the Mutual Fund Regulations. With the
bifurcation of the erstwhile UTI which had in March 2000 more than Rs.76,000 crores
of assets under management and with the setting up of a UTI Mutual Fund,
conforming to the SEBI Mutual Fund Regulations, and with recent mergers taking
place among different private sector funds, the mutual fund industry has entered its
current phase of consolidation and growth.

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The graph indicates the growth of assets over the years.

GROWTH IN ASSETS UNDER MANAGEMENT
Note:
Erstwhile UTI was bifurcated into UTI Mutual Fund and the Specified Undertaking of the
Unit Trust of India effective from February 2003. The Assets under management of the
Specified Undertaking of the Unit Trust of India has therefore been excluded from the total
assets of the industry as a whole from February 2003 onwards.

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ABOUT MAHINDRA & MAHINDRA FINANCIAL SERVICES

LIMITED
Investment Advisory Services

Company Profile
Mahindra & Mahindra Financial Services Limited, a subsidiary of Mahindra &
Mahindra Limited, was established in the year 1991 with a vision to become the
number one semi-urban and rural Finance Company. In a short span of 12 years, it has
become one of the India’s leading non-banking finance company providing finance
for acquisition of utility vehicles, tractors and cars. It has more than 350 branches
covering the entire India and services over 6,00,000 customer contracts.
It is a part of US $3 bln Mahindra Group, which is among the top 10 industrial houses
in India. Mahindra & Mahindra is the only Indian company among the top five tractor
manufacturers in the world and is the market leader in multi-utility vehicles in India.
The Group is celebrating its 60th anniversary in 2005-06. It has a leading presence in
key sectors of the Indian economy, including trade and financial services (Mahindra
Intertrade, Mahindra & Mahindra Financial Services Ltd.), automotive components,
information technology & telecom (Tech Mahindra, Bristlecone), and infrastructure
development (Mahindra GESCO, Mahindra Holidays & Resorts India Ltd., Mahindra
World City). With around 60 years of manufacturing experience, the Mahindra Group
has built a strong base in technology, engineering, marketing and distribution. The
Group employs around 30,000 people and has eight state-of-the-art manufacturing
facilities in India spread over 500,000 square meters.
Mutual Fund Distribution
Recently it has received the necessary permission from Reserve Bank of India (RBI)
to start the distribution of Mutual Fund products through its network. Hitherto the
company was only participating in the liability requirements of its customers and with
mutual fund distribution business, it can also participate in their asset allocation.
When it comes to investing everyone has unique needs based on their own objective
and risk profile. Even though many investment avenues such as fixed deposit, bonds
etc. exists, equities typically outperform these investments, over a longer period of
time. We are of the opinion that, systematic investment in equity will allow you to
create Wealth.

15
Hence only through proper allocation of your portfolio, you can get the maximum
return with moderate risk. Investing in equity is not as straight forward as investing in
bonds or bank deposits. It requires expertise and time. Our Investment Advisory
services will help you to invest your money in equity through different Mutual Fund
Schemes. For instance there are some products of Mutual Fund, which allows you to
manage your cash flow by providing liquidity (liquid Funds) as well give you tax free
return.
Personalized Service
We believe in providing a personalized service enabling individual attention to
achieve your investment goal.
Professional Advice
We provide professional advice on equity and debt portfolio with an objective to
provide consistent long-term return while taking calculated market risk. Our approach
helps you to build a proper mix of portfolio, not just to promote one individual
product. Hence your long term objective are best served.
Long-term Relationship
We believe steady wealth creation requires long-term vision, it can’t be achieved in a
short span of time. To achieve this one needs to take advantage of short-term market
opportunity while not loosing sight of long term objective. Hence we partner all our
clients in their objective of achieving their long-term Vision.
Access to Research Reports
Through us, you will have access to certain research work of CRISIL, so that you will
benefit from the expert knowledge of economists and analysts of one of the leading
financial research and rating company of India. This third party research gives you a
comfort of getting unbiased advice to make a proper decision for your investment.
Transparency & Confidentiality
Through email you will get a regular portfolio statement from us. You will also be
given a web access to view at your convenience the details of your investments and its
performance. Access to your portfolio is restricted to you and our monitoring system
enables us to detect any unauthorized access to your investments.
Flexibility

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To facilitate smooth dealing and consistent attention, all our clients will be serviced
by their respective relationship executive. This allows us to provide tailor made
advice to achieve your investment objective.
Hassle Free Investment
Our relationship person will provide you with a customized service at your
convenience. We take care of all the administrative aspects of your investments
including submission of application forms to fund houses along with monthly
reporting on overall state of your investments and performance of your portfolio.

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CHAPTER2
REVIEW OF LITERATURE

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Advertising in the mutual fund business and the role of judgmental heuristics in
private investors’ evaluation of risk and return
Effective advertising strategies are of growing importance in the mutual fund industry
due to keen competition and changes in market structure. But the dominant variables in
financial decision making, investor’s perceived investment risk and expected return,
have not yet been analysed in an advertising context, although these product- related
evaluations can be influenced by advertising and therefore serve as additional
indicators of advertising effectiveness. In this study, I have used a large-scale
experimental study (n=100) to detect how risk-return assessments of private investors
are influenced by specific elements of print ads. In this context, judgmental heuristics
used systematically by private investors play a crucial role.
Advertising in the Mutual Fund Industry

After 2003, the mutual fund industry was one of the fastest growing market sectors in
India. Assets held in mutual funds rose from less than Rs 2000 crores at the beginning
of the decade to Rs 87,000 crores by the end of 2003. Due to fierce competition
resulting from the internationalisation of financial markets, technological changes and
fundamental changes in private households’ investment behaviour, effective
marketing strategies are of great importance in the mutual fund business, and
advertising has become an important marketing instrument to attract fund sales.
Accordingly, advertising expenditures of mutual fund companies increased
significantly in the last years. In Germany, they rose to 145.61m in 2001, which is
more than twice as high as three years before (66.75m).
Similar developments can be found in other European countries and in the USA. But
what is known about the way advertising works in the mutual fund business? There is
no doubt that many theoretical and empirical findings of behavioural advertising
research apply to investment products too, for instance the attainment of brand
awareness or the creation of emotional experiences through advertising. There are,
however, special features of investment products which advertising research should
analyse explicitly. Above all, investment decisions are characterised by high
exogenous uncertainty, as future product performance must be estimated from a set of
noisy and vague variables. So investors’ expectations about uncertain future events
play a crucial role in investment decision making. Most importantly, purchase

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decisions in investment markets follow two dominant criteria: perceived investment

risk and expected return, constructs which apply exclusively to investment products.
Risk and return are crucial variables in financial decision making, as indicated in the
fundamental normative model of investment behaviour, the mean-variance portfolio
analysis. Financial services advertising should aim to influence positively investors’
perceptions of these product-specific decision criteria. This paper delivers theoretical
and empirical insights into the influence of advertising on private investors’ risk-
return perceptions. Hypotheses are tested by means of a large-scale experimental
study, and practical implications are deduced in the last section of the paper. product-
specific variables of advertising effectiveness in order to understand and optimise
advertising’s persuasive impact in this special business.
In finance theory, investment risk is considered a precise, abstract and purely technical
statistical concept. This risk concept, however, does not reflect private investors’
understanding of risk; they have a more intuitive, less quantitative, rather emotionally
driven risk perception. Empirical studies that deal with investors’ risk perceptions
detect four different dimensions of perceived risk:
— Downside risk: the perceived risk of suffering financial losses due to negative
deviations of returns, starting from an individual reference point
— Upside risk: the perceived chance of realising higher-than-average returns,
starting from an individual reference point
— Volatility: the perceived fluctuations of returns over time
— Ambiguity: a subjective feeling of uncertainty due to lack of information and
lack of competence.
These different aspects have to be taken into account, as single item measures lead to
an incomplete and simplified measurement of the perceived risk construct.Expected
return, on the other hand, is a simpler, one-dimensional numerical construct, which
can be measured in absolute or relative terms.
Effects
Risk perception and return estimations are crucial constructs in the context of
financial decision making. Traditional behavioural advertising research, however,
focuses on rather general categories of advertising effects, like awareness, recall or

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attitude change. Regarding investment products, private investors’ risk-return

perceptions should be treated as additional, in intuitively quantitative evaluations.
The Relevence of Private Investors’ Judgmental Heuristics for Risk- Return

Perceptions and Advertising Content
Behavioural finance, a field of research at the interface of economics, finance and
psychology, is a relatively new paradigm and was developed in the late 1980s in the
USA due to mounting empirical evidence that existing financial theories appeared to
be deficient in a real market setting. Contrary to the normative approach of classical
portfolio theory, behavioural finance deals with the descriptive analysis of actual
behaviour of individuals in financial markets and analyses psychological influences on
information processing and financial decision making. The typical investor is
considered to be a ‘homo heuristics’ rather than a ‘homo economicus’ who makes use
of judgmental heuristics in information processing and decision making instead of
formal statistical analysis. Judgmental heuristics are abridged, often sub-optimal
information processing strategies, so-called ‘mental shortcuts’ or ‘rules of thumb’
which are used systematically but often unconsciously to simplify decision making.
Heuristics like the anchoring heuristic, the representativeness heuristic, the
availability heuristic or framing lead tobiases in the perception of risks and returns.
So if advertising content evokes the use of judgmental heuristics, advertising will
influence investors’ risk- return perceptions by means of those heuristics.
In the next sections, Explanation about two cognitive heuristics and one affect-based
heuristic and deduction of the implications for advertising effects are given. The
heuristics were chosen on the basis of their practical relevance in actual mutual fund
advertising.
Anchoring heuristic
While making forecasts, predictions or probability assessments like risk-return
evaluations of mutual funds, people tend to rely on a numerical anchor value which is
explicitly or implicitly presented to them. Anchoring effects are not restricted to
numerical values with a logical coherence to the subsequent numeric estimate.
According to the so- called ‘basic anchoring effects any random and uninformative
starting point might represent an initial anchor value which leads to biases in forecasts

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and estimates of the value of that initial starting point. Anchoring effects have been
identified in many empirical studies and in various decision fields. This robust
judgmental heuristic is of particular relevance in financial markets, where it applies to
any financial forecast (eg stock market prices), leading to severe biases. In practice,
numerical data play an important role in the informative content of mutual fund ads.
Almost every print ad and many television spots highlight figures like past
performance data, assets under management, distribution of dividends etc. In addition
to direct anchor values (these are anchors that evoke direct associations with risks and
returns, eg ‘10 per cent’), indirect anchor values with dimensions other than return or
monetary units, eg ‘15,000 research specialists worldwide’, ‘Value Basket Fund’,
‘1,000 dreams come true’) can also exert an influence on estimates. In accordance
with the anchoring heuristic, even those irrelevant figures will distort return-
perceptions of the anchor value when they are prominently highlighted in the ad.
H1: A low anchor value in an ad will lead to a lower return estimation, compared to a
high anchor value, even when the anchor is uninformative in nature.
Representativeness heuristic People tend to rely on stereotypes. They judge the
likelihood of an event in accordance to its fitting into a previously established schema
or mental model. They consistently judge the event that seems to be the more
representative to be the more likely, without considering the prior probability, or base-
rate frequency of the outcomes. Representativeness is a commonly used and very
problematic heuristic in financial markets, as it leads to a misinterpretation of
empirical or causal coherence. Illusory correlation, betting on trends, naı¨ve causality,
misperception of randomness and other related biases in the use of judgment criteria
are typical consequences. For instance, past performance data and trend patterns of
mutual funds’ performance charts are extrapolated into the future without considering
the exogenous uncertainty and randomness of financial markets. In terms of practice,
mutual fund ads suggestively promote stereotype thinking by communicating positive
past performance data, fund ratings and fund awards, and by pointing out specific
brand values like trustworthiness, competence and experience. Due to stereotypical
thinking (thinking in brand associations and brand schemata), risk-return perceptions
of private investors will heavily depend on the investment company that stands behind
the investment product. With regard to investment products, however, investors’

22
reliance on brand images or brand stereotypes in the evaluation of risks and returns is
a severe anomaly, as strong brands cannot serve as a warranty for high returns or low
risks due to the exogenous uncertainty of financial markets.
H2: A well-known investment company with a clearly positive brand image will
evoke better risk-return perceptions at the product level compared to a relatively
unknown investment company lacking a clear and positive brand image profile,
although identical products are advertised and identical product information is
provided affect heuristic
Modern financial theory increasingly recognises the fact that financial decision
making is also determined by affective states. Negative emotions like fear, worry,
anger or shame, and positively experienced emotions like hope, greed, pleasure and
joy may influence risk-return perceptions and investment behaviour. A direct influence
of emotions on risk perception and expected returns can be deduced from the ‘affect
heuristic’ which postulates that perceptions of risks and benefits of an alternative are
derived from global affective evaluations and associations. If a stimulus arouses a
positive affective impression, the decision maker will judge the risks related to this
alternative to be lower and the benefits (eg returns) to be higher, compared to neutral
emotional states. If a stimulus is associated with negative affective impressions, the
opposite effect will occur: risks are judged to be higher, the returns, on the other hand,
to be lower. In practice, mutual fund ads most often contain emotional pictures and
emotional slogans as well as product information. In terms of the affect heuristic,
these emotional elements exert a direct influence on investors’ risk-return perceptions
if they succeed in evoking positive affective impressions of the mutual fund.
H3: If the emotional content in the ad (pictures, slogans, tonality) succeeds in evoking
positive affective impressions of the advertised mutual fund, the investor will judge
the investment risk to be lower and the return to be higher than a purely informative
ad.
The moderating impact of private investors’ expertise

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It is important to discuss possible moderating factors in the use of heuristics.

Do only inexperienced, uninformed investors use these heuristics,
or are they also applied by novice and expert investors?
The question whether or not knowledge has an influence on heuristic information
processing has been controversially discussed. Some researchers underline the
unconsciousness and automatism of judgmental heuristics, implying that both lay and
expert investors systematically make use of them. Indeed, some empirical findings
reveal that investors’ expertise has no influence on the use of judgmental heuristics.
Others, however, demonstrate the moderating role of individuals’ knowledge, stating
that knowledgeable persons do not apply judgmental heuristics, or only to a moderate
extent.
Discussion
Advertising in the mutual fund industry may become more effective if advertising
firms are aware of and apply theoretical and empirical insights of behavioural
finance theory, especially regarding investors’ systematic use of judgmental
heuristics in the evaluation of risk and return. Besides more general variables of
advertising effects, it is reasonable to consider private investors’ risk-return
perceptions as additional, product-specific variables of advertising effects in the
mutual fund industry in order to understand and optimise advertising effectiveness.

Private investors make use of judgmental heuristics during the processing of
advertising stimuli, regardless of their expertise in investment decisions.
Uninformed investors, however, make use of heuristics to a larger extent, resulting
in larger biases in the perception of risks and returns. This finding highlights the
necessity of target group- or market segment-specific advertising strategies in the
investment industry, as differences in knowledge and experiences lead to different
risk-return perceptions. Numerical values in print ads serve as anchor values and
bias expected returns, even when there is no logical connection between anchor
value and return estimation. Therefore, prominent numbers and figures in mutual
fund ads have to be integrated very carefully, with full awareness of their potential
biasing influence.

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Brand awareness and brand image play a central role in the processing of ads, as they
are able to distort private investors’ risk perception at the product level. Investment
risk is judged lower if a highly reputable and well-known investment company offers
the advertised mutual fund. As a consequence, investing in brand equity is very
important. Private investors’ risk perceptions are influenced by emotional states.
Emotional stimuli in the ad not only lead to a more favourable, positive affective
evaluation of the advertised mutual fund, but also to a lower perception of investment
risk compared to a merely informative advertising style. This finding indicates that
emotional advertising is an effective tool, even in the abstract, rational, risk- return-
oriented investment industry.
The Impact of Consumer Knowledge, Involvement, and Risk Willingness on

Return on Investments in Mutual Funds and Stocks
Consumer knowledge, involvement, and risk are central concepts in consumer
behavior research. A review of prior research shows however that there is
no universally agreed understanding of how these concepts should be defined, nor
on how they are related in terms of antecedents, dimensions, and consequences. In
this study the relationship between these key concepts were explored and their
impact on consumers’ return on investments in mutual funds was analyzed.
Theory based alternative relationships were systematically tested in SEM
analyses. The study sheds new light on the knowledge concept by showing
that the knowledge construct should be modeled in terms of three dimensions
(ability, opportunity, and familiarity) in complex decision contexts (mutual funds
and stocks). The hypothesized importance of domain specific knowledge was
confirmed and a mediation analysis showed the relations of involvement and risk
willingness to knowledge and returns. Consumers’ ability and opportunity to get
access to stock market information is strongly related to their involvement, which
in turn influence both familiarity and risk willingness. Risk willingness has a
stronger effect on return than does familiarity.
In the last decade, almost all employed consumers have, intentionally or unin-
tentionally changed from being savers to being investors on the stock market.
Whereas 50% of consumers in most industrialized countries own mutual funds,
the figure can be higher for indirectly own mutual funds within a pension

25
system. Sweden, as an example, has a record number of indirect investors (more than
90% of the population 18–74 years old). In the trade press as well as in peer reviewed
journals (e.g., Capon et al., 1996) the growth of the mutual fund industry has been
described as a revolution; ‘In fact, it’s no overstatement to suggest that this
movement from Wall Street to Main Street is one of the most
significant socioeconomic trends of the past few decades’ (Serwer, 1999). These
consumers make risky decisions involving large amounts of money. To make
wise financial decisions, they must be able to determine how much information is
needed, which information is most useful and what sequence of information
acquisition is best for them (Jacoby et al., 2001). Their ability, motivation and
opportunity to do so influence what return they may expect on their investments.
But the overwhelming amount of technical stock market information makes it
impossible for consumers to evaluate the quality of the mutual funds on the market
(e.g., Sandler, 2002; Aldridge, 1998). The situation on the stock market is, thus,
typically a situation where many consumers would use heuristics in quality
assessments (Dawar and Parker, 1994) they
1) have a need to reduce the perceived risk of purchase;
2) they lack expertise and consequently the ability to assess quality;
3) their involvement is low (e.g., Benartzi and Thaler, 1999; Foxall and
Pallister, 1998);
4) objective quality is too complex to assess or they are not in the habit of spending
time objectively assessing quality; and
5) there is a need for information.
While heuristics may serve a purpose in many other situations of less complexity,
they may be dangerous to use on the stock market. Therefore, it does not
come as a surprise that consumers who use heuristics to make complex financial
decisions are described as naıve (Capon et al., 1996) and that they are regarded to be
in an unusually weak position on the financial market (e.g., Sandler, 2002). The
fact that shopping for financial instruments increasingly has become like
shopping for many other consumer items (Wilcox, 2001) and with entrepreneurs
like Virgin entering the market, consumers may not realize the risks of making
bad investment decisions. However, the long-term negative consumer welfare
implications from poor investments have been estimated to be in the hundreds of
thousands of dollars for individual consumer investors (Lichtenstein et al.,

26
1999). That will have a large impact on their future welfare. Extensive prior
research of behavioral data shows that there are two types of nonprofessional
investors, namely sophisticated and unsophisticated investors. Unsophisticated
investors (the majority) direct their money to funds based on advertising and
advice from brokers (Gruber, 1996), and their involvement is low (Foxall and
Pallister, 1998). The current practice in mutual fund advertising is to emphasize
past performance and advertised funds attract significantly more money than
comparable funds that are not advertised (Jain and Shuang Wu, 2000). Past
performance is however not associated with future results (ibid.), which may explain
why unsophisticated investors get lower return on investments.
This brief review indicates that there are certain key variables that need to be
considered in an holistic study. Prior research (e.g., Alba and Hutchinson,
1987; Lichtenstein et al., 1999; Jacoby et al., 2001) emphasizes the important
role of consumer knowledge. The effects of knowledge on consumer behavior can
however not be regarded only as main effets, but must be studied along with a wide
range of moderating variables (Alba and Hutchinson, 1987). Within consumer
behavior (CB) involvement is assumed to influence subsequent consumer behaviors
(e.g., Alba and Hutchinson, 1987; Zaichkowsky, 1985a, 1985b, 1986, 1994; Laurent
and Kapferer, 1985; Dholakia, 2001). The cornerstone principle in traditional
finance is that expected return on investments in stocks is positively related to
willingness to take risks (Shefrin, 2001), and most research on mutual funds has
employed these two explanatory variables, i.e., risk and return (Capon et al., 1996).
Harry M. Markowitz, Nobel Laureate in Economic Sciences 1990, has argued that
investors can not expect a higher return than for example the bank interest rate if they
are not willing to take risks (Bernhardson, 2004).
The aim of this study is to explore and clarify the relationships among the
key constructs and to develop a parsimonious model that captures the
relative importance of these constructs on return on investments in mutual
funds and stocks (MF&S). Earlier research on knowledge, involvement and risk has
focused on perceptual variables only, not on what matters most to consumers and
firms alike; actual behavior and the consequences of behavior. This has
hampered the cumulation of knowledge about relationships between important
constructs in CB. Comparing and contrasting mental phenomena with actual

27
behavior has special research benefits (Mick, 2003). Poiesz and de Bont (1995)
concluded for example that there is a lack of conceptual clarity, a seemingly
uncontrolled application, an overlap with presumed antecedents, and an
unavoidable lack of consistent operationalisa- tions of the involvement concept.
Similarly, Dholakia (1997) concluded that there is confusion in the literature whether
perceived risk should be treated as an antecedent of involvement, one of its
dimensions, or as its consequence. Laurent and Kapferer (1985) regarded perceived
risk (i.e., risk avoidance and negative consequences) as an antecedent of situational
involvement, whereas Venkatraman (1989) and Dholakia (2001) suggested that
enduring involvement precedes risk. None of them discussed situations where
consumers are willing to take risks (e.g., investments in mutual funds). Diacon
and Ennew (2001) who studied risk perceptions of UK investors included
(poor) knowledge as a dimension of risk perception rather than treating
knowledge as a separate construct. Researchers who have studied consumers
with high versus low knowledge have done so with no regard to the involvement
studies. No research has simultaneously compared the relative influence of these
three important constructs on behavioral intentions or behavior, which is similar
to the situation that prevailed in service marketing regarding the role of quality,
value, and satisfaction on behavioral intentions (e.g., Cronin et al., 2000).
There is also a general lack of contributions from the academic world in this
important domain (complex decisions or savings in MF&S) that can have
a tremendous impact on consumers’ welfare (Bazerman, 2001; Lehmann, 1999;
Lichtenstein et al., 1999; Mick, 2003). In the present study, therefore,
we systematically examined a variety of relations between the relevant key
constructs (knowledge, involvement, risk willingness, and return). Even though
the literature suggests various relations between these constructs, the guidance is
not strong enough to formulate a specific model. Therefore, the modeling task
corresponds to what Jo¨reskog (1993: 295) calls the Model Generating
(MG) situation. The alternative links between concepts in the alternative models
tested were derived from previous literature. We used a nationally representative
sample of owners of MF&S.
In terms of methodology we focused more on generalizability than on precision and
realism. Conceptually, the focus was more on parsimony than on differentiation of

28
detail or on the scope of the focal problem (Brinberg and McGrath, 1985: 43). These
choices seemed quite natural considering the importance of mutual funds to
most consumers, the lack of earlier research in the field, and the need
to use a representative sample to get enough variety in the answers. To summarize,
this study will clarify relations between knowledge, involvement and risk, and it will
estimate their impact on consumers’ return on investment in MF&S.
The report is organized in the following way. First, earlier research on the key
constructs is reviewed. Then the analyzed alternative models derived from the
literature are described. Third, results from the analyses of the alternative
models are presented in the following sequence: the knowledge construct,
alternative relations between knowledge and involvement, and alternative
relations between knowledge, involvement, risk willingness and return on
MF&S investments. Fourth, results are evaluated and interpreted and the
limitations of the study are acknowledged.
Theoretical Background
Consumer Knowledge
In a classic study of consumer knowledge Alba and Hutchinson (1987) made a
fundamental distinction between two major components of knowledge: expertise and
familiarity. Expertise has been defined as ‘knowledge about a particular
domain, understanding of domain problems, and skill about solving some of these
problems’ (Hayes-Roth et al., 1983: 4). It is difficult to be an expert on the stock
market. Earlier research compiled from different sources (Jacoby et al., 2001)
indicates that general market and industrywide factors (e.g., deregulation of an
industry) account for perhaps 40%–50% of the changes in a stock’s price,
approximately 300 fundamental factors (those involving a company’s financial
statement) account for approximately 30%–35% of the variance, and that other
company-unique non-financial variables (e.g., changes in leadership) account
for 20%–25% of the variance. It is, consequently, almost an understatement
to say that financial decision-making is a complex and multifaceted task. An
American survey showed for example that 66% of mutual fund investors could not
confidently name a single company in which their mutual funds invest (from
Krumsiek, 1997). The majority, 58%, of the respondents (employees at USC) in

29
Benartzi and Thaler’s (1999) study spent an hour or less on their retirement allocation
decision, and they read only the material provided by the vendors and consulted only
family members. Nonetheless they expressed confidence that they had made the right
choice and many of them never changed their initial choice. Against this
background it may come as no surprise that large groups of consumers both in
the US and in Europe are classified as financially illiterate. That is considered a major
problem in many countries (Aldridge, 1998; Nefe, 2002; Sandler, 2002).
Earlier research has found systematic differences between better and poorer
performers (professional analysts) in regard to the type of information access
(the content of the search), the order in which different items of information are
accessed (the sequence of the search) and the amount of information accessed (the
depth of the search) (Jacoby et al., 2001). Better performers engage in
significantly greater amounts of within-factor search. They select one factor, such as
earnings per share, and check its value for all stocks of interest before moving
on to the next factor. Poorer performers tend to do more ‘within-stock’ search. They
select one stock and check its value on all factors of interst. The better-performing
analysts tend to access more information overall and maintain the same relatively high
level of information search across all four periods of the task, while the poorer
performers typically taper off their search considerably after the first period.
Similar results were found by Hershey and Walsh (2000–2001). They found that
experts are more goal-oriented and efficient and are able to impose a
meaningful structure on ill-structured tasks and focus their attention on a
smaller number of more diagnostic items of information. The prior knowledge
of the range of acceptable parameters for a variety of variables allows experts to form
a general impression of whether an investment is indicated or not, and on that
basis they are able to specify a reasonably accurate intuitively based investment
amount. Novices are more likely to sample the opinions
of others and to use ‘nonfunctional’ attributes such as brand name and price.
In extreme cases, they may rely primarily on brand familiarity. As novices gain some
familiarity with the problem domain they simplify their solutions, whereas experts
continue to solve the problems at a consistent level of complexity across trials.
Familiarity was defined as the number of product-related experiences that have
been accumulated by the consumer (Alba and Hutchinson, 1987). Experience gives a

30
feeling of security and consequently a higher propensity to accept risks. When

decision-makers see themselves as more competent and knowledgeable, they are
more likely to see chance events as controllable and believe that they have
skills enough to predict events on the market (Langer, 1983). That feeling
(confidence knowledge) makes them more prone to attempt to master their
environment. Antonides and Van Der Saar (1990) found for example that the
perceived risk of an investment is lower the more the stock price has increased
recently.
Involvement
Consumers’ (enduring) involvement was defined as the on-going mobilization of
behavioral resources for the achievement of a personally relevant goal (as opposed to
Poiesz and de Bont, 1995, who discussed momentary mobilization).
Involvement was seen as the consequence of the combined subjective
assessments of motivation, ability and opportunity to seek, access, interpret
and evaluate task-relevant information. As noted by Petty and Cacioppo (1981: 23,
emphasis added), ‘the level of involvement is not the only determinant of the route to
persuasion. In addition to having the necessary motivation to think about issue-
relevant argumentation, the message recipient must also have the ability to process
the message if change via the central route is to occur’. Opportunity was in their
definition subsumed under ability. This implies that high personal relevance may
be associated with low involvement, and that involvement may be considered a
determinant or antecedent to behavioral phenomena (Poiesz and de Bont, 1995).
Most consumer researchers (e.g., Laurent and Kapferer, 1985; Zaichkowsky,
1985a, 1985b, 1986, 1994) have focused on the motivational aspects of
involvement only and not on the behavioral aspects of it. Furthermore, most consumer
behaviour (CB) research on involvement deals with familiar search products rather
than with complex credence products. That difference may explain why earlier
CB research has not included ability and opportunity when defining involvement.
As noted by Poiesz and de Bont (1995: 450), ‘to the extent that ability and
opportunity conditions become more favorable, the difference between personal
relevance and involvement becomes smaller’. This study deals with a domain
where the ability and opportunity conditions are highly unfavorable.

31
Risk Willingness
As noted by Dholakia (2001: 1342), ‘an important property of risk conceptualization
within consumer psychology is that risk is thought to arise only from
potentially negative outcomes, in contrast to other disciplines such as behavioral
decision theory and other areas of psychology, where both positive and negative
aspects are considered when evaluating risk’. Research on risk avoidance is of
limited relevance in this study. Consumers wishing to avoid risk do not buy mutual
funds, since risk is inherent in all stock market products. Consumers may however try
to minimize risks. Venkatraman (1989) as well as Dholakia (2001) suggested that
since enduring involvement is a long-term product concern while perceived risk
is limited to the purchase situation, enduring involvement precedes risk. In this
study it was assumed that perceived risk willingness is an enduring phenomenon
which lasts as long as you own mutual funds. It is extremely hard for people to think
about uncertainty, probabability, and risk (Slovic, 1984). Repeated demonstrations
have shown that most people lack an adequate understanding of probability
and risk concepts (Shanteau, 1992). Furthermore, there is no universally
agreed understanding of how risk should be conceptualized or measured (Diacon
and Ennew, 2001). But, it is generally agreed that the stock market is driven by
expectations about future returns and by risk perceptions, where psychological
risks may dominate over simple facts. Most people’s beliefs are biased in the
direction of optimism, and they also underestimate the likelihood of poor outcomes
over which they have no control (Kahneman and Riepe, 1998). Empirical studies
have shown that consumers often claim that they ‘take calculated risks’, but
that they ‘do not gamble’ (De Bondt, 1998). Many households are however
underdiversified, and do not define risk at portfolio level but rather at the level of
individual assets. In these contexts, risk is seen as controllable. Based on a review
of prior studies Diacon (2004: 182) concluded that ‘risks are perceived as being
more severe if an individual has little information or control over what may happen’.
Risk taking in a bull (hausse) market may create an illusion of control, i.e., an
expectancy of a personal success probability inappropriately higher than the
objective probability would warrant (Langer, 1983: 62). This may be explained
by the fact that consumers lack appropriate reference points (Lichtenstein et
al., 1999).

32
Financial Returns
Consumers take a big risk when they invest money in the stock market as opposed to
traditional bank deposits or bonds. Consequently, they are willing to take that risk to
get a higher return than they would get from traditional savings. There is no earlier
CB research on the return concept, but the success of advertising campaigns focusing
on past returns indicates that consumers are prone to listen to the high return
argument. Such advertising is one of the most important sources of information for
individual fund investors when making investment decisions (Capon et al.,
1996; Fondbolagens Fo¨rening, 2004). The content in fund advertisements
includes information on past returns and independent research (e.g., Morningstar),
whereas measures of costs and risks are absent (Jones and Smythe, 2003).
Analyzed Models
It is well known in the trade that the majority of consumers are reluctant to
buy complex financial products, and that they, in many cases, must be sold to buy
the product. It is therefore reasonable to assume that consumers must have a
minimum amount of motivation, ability and opportunity to get access to
and process information about the stock market. Without motivation, one
does not acquire expertise in such a complex domain. By adopting the definition of
involvement in the stock market used by Petty and Cacioppo (1981) as well as by
Poiesz and de Bont (1995) it follows that involvement is a consequence of
expertise. Furthermore, in this particular domain, it would be unlikely to find
consumers with expertise and involvement who do not use their knowledge for
investment purposes, i.e., thereby getting familiarity. Familiarity, in turn, may create
an illusion of control and consequently a higher willingness to take risks. Risk
willingness may therefore be seen as a consequence of involvement via
familiarity. However, there may be alternative models that would describe
relations between constructs in a more accurate way. Unfortunately, as already
mentioned, no previous research has simultaneously compared the relative
influence of three of the major constructs in this study, namely knowledge (expertise
and familiarity), involvement and risk (neither risk willingness nor risk avoidance)
on behavioral consequences. Earlier studies have, as mentioned, focused on the
perceptual concepts only. That explains the contradictory findings that for example
Poiesz and de Bont (1995) discussed regarding antecedents, dimensions, and

33
consequences of the involvement concept. It was therefore considered essential to

test alternative models to improve our understanding of the relations between
these concepts.
The first alternative was to treat knowledge as a one-factor model rather than as a
two factor-model (expertise and familiarity) as suggested by Alba and Hutchinson
(1987). In a preliminary study Zaichkowsky (1985b) emphasized that
expertise should be separated from familiarity (product use), but she studied search
products rather than complex credence products.
A second alternative is that involvement precedes knowledge rather than the
other way around as in the proposed model. The involvement literature on search
products would favor this alternative. Zaichkowsky (1985) also found that
involvement and product use (familiarity) may be related, while involvement and
expertise may not necessarily be related.
These two alternative models were also tested. Return on investments in
MF&S is the dependent variable and risk and return are related. Alternative
relations for the risk willingness concept were also tested.
Return and Risk on Common Stocks

The capital asset pricing model (CAPM) of Sharpe (1964) and others
suggests that the total risk of an asset can be dissected into a market related
component or systematic risk, and a company specific component or idiosyncratic
risk. Idiosyncratic risk can be diversified away by investors and is therefore not
priced in an efficient capital market. Systematic risk, measured by the asset s beta,
is therefore the only relevant measure of risk in an informationally efficient
market. Accordingly, in an efficient market, the CAPM predicts a linear
relation between security returns and beta.
As predicted by the CAPM, several studies using sample periods prior
to 1969 find significant linearity between beta and stock returns (Miller and
Scholes, 1972; Black, Jensen, and Scholes, 1972; Fama and MacBeth,
1973).Miller and Scholes (1972) find a linear association between average
returns and beta, as well as a positive association between average returns and
idiosyncratic risk, using a 1954 to 1963 sample period. In line with other previous
studies, which they report, they find that the relation between idiosyncratic
risk and average returns is even stronger than between beta and average returns.

34
They also find a linear relation between beta and idiosyncratic risk. Black, Jensen,
and Scholes (1972) report a positive linear relation between average returns and
beta and demonstrate that the relation between average returns and beta for 17
non-overlapping two year periods, from 1932 to 1965, is unstable and negative for
at least 7 of the 17 periods. Finally, Fama and MacBeth (1973) find a linear relation
between average returns and beta from January 1926 to June 1968, and find that no
measure of risk besides beta systematically affects expected returns.
Recent studies are not supportive of linearity between beta and security
returns. Fama and French (1992) find that, controlling for firm size, stock beta is
not linearly related to average returns from 1963 to 1990.1 Their results are
supported by Malkiel and Xu (1997), who suggest that firm size is a better proxy of
risk than stock beta. Furthermore, Malkiel and Xu (2002) find that beta estimated
using the market model is important in explaining cross-sectional return
differences from 1935 to 1968, but that beta s role weakened considerably
during the more recent 1963 to 2000 period.2 Idiosyncratic risk, on the other
hand, is important in both periods whether it is measured using the market
model or the Fama and French (1992) three-factor model.
The relation between average returns and such firm characteristics as
size, price-to- earnings (P/E) ratio and price-to-book (P/B) ratio are well
documented. For example, Banz (1981) finds that firm size varies negatively
with average returns.3 Basu (1983), on the other hand, demonstrates that P/E ratio
varies negatively with average returns even after controlling for the effect of firm size.
Furthermore, Rosenberg, Reid and Lanstein (1985) find that P/B ratio varies
negatively with average returns, and Fama and French (1992) find a strong
univariate relation between average returns and both firm size and P/B ratio. Using a
bivariate regression, Fama and French (1992) show that firm size and P/B ratio
together absorb the role of P/E ratio in stock returns. They argue that stock
risks are multidimensional, one dimensionof risk proxied by firm size and another
proxied by P/B ratio. Moreover, Malkiel and Xu (1997) report that both firm size and
P/B ratio appear to be good proxies of risk over the 1963 to 1994 sample period.
Is Idiosyncratic Risk Relevant?

35
Studies that find significant association between idiosyncratic volatility and

stock returns include Miller and Scholes (1972), Friend, Westerfield, and
Granito (1978), Levy (1978), Amihud and Mendelson (1989) and Lehman
(1990). In line with Miller and Scholes (1972), Malkiel and Xu (1997) find a
significant linear relation between idiosyncratic risk and average returns. Their
results indicate that the relation between idiosyncratic risk and average returns is
even stronger than between firm size and returns. Malkiel and Xu also find a
negative relation between idiosyncratic risk and firm size and suggest that
idiosyncratic risk is a proxy for firm size and is perhaps a proxy for a wide range of
systematic factors. They argue that idiosyncratic risk may serve as a useful risk
proxy since portfolio managers are often called upon to explain why they invest in a
stock that declined considerably during a reporting period. Accordingly, such
portfolio managers may demand a risk premium on individual stocks with high
perceived idiosyncratic risk.
Noting that a significant proportion of investors are either not able or not willing to
hold the market portfolio, Malkiel and Xu (2002) contend that idiosyncratic risk could
be priced to compensate investors who are not fully diversified. Malkiel and Xu
(2002) show that idiosyncratic volatility is more powerful than either beta or
firm size in explaining the cross- sectional differences in stock returns. They
show also that the explanatory power of idiosyncratic volatility is not
subsumed by either firm size or P/B ratio. Furthermore, Goyal and Santa-Clara
(2003) show that lagged average stock variance, which they find to be mostly driven
by idiosyncratic volatility, is positively related to returns on the market. They find
this relation to be stronger for smaller firms after controlling for the effect of P/B
ratio.Campbell, Lettau, Malkiel and Xu (2001) find that idiosyncratic volatility
is the largest component of the total volatility of an average firm from1962 to
1997. They also find a significant positive trend in idiosyncratic volatility and
find no significant trend in market volatility during that period. They
demonstrate that the increase in idiosyncratic volatility from1962 to 1997 has
increased the number of randomly selected stocks needed to achieve a relatively
complete diversification. For example, 20 stocks reduced annual excess standard
deviation to 5% from 1963 to 1985, whereas 50 stocks were required to achieve the
same level of diversification from 1986 to 1997.
Idiosyncratic Risk and Mutual Fund Return

36
The purpose of the present study is to find out if previous evidence regarding
the relation between common stock return and idiosyncratic risk can be generalized to
mutual fund prices. A secondary objective is to investigate the relation between
mutual fund return and price-to-book (P/B) ratio, price-to-earnings (P/E)
ratio, price-to-cash-flow(P/C)ratio, and market capitalization of the
companies held by mutual funds. According to the CAPM, there should be no
significant linear relation between return and idiosyncratic volatility. There should
also be no linear relation between return and such firm characteristics as P/B ratio,
P/E ratio, P/C ratio and market capitalization unless such characteristics are proxies of
systematic risk. However, since previous studies of common stock return find positive
relation between idiosyncratic volatility and return, as discussed above, I predict
a positive relation between mutual fund return and undiversified-idiosyncratic
volatility. I also predict a negative relation between mutual fund return and P/B
ratio, P/C ratio, P/E ratio, and the capitalization of companies held by mutual funds.
Moreover, I predict positive relation between return and fund’s net assets, since
mutual fund costs are known to vary inversely with fund size.
The increase in idiosyncratic risk for individual stocks over time, the
decline in the explanatory power of the market model, and the increase in the
number of randomly selected stocks needed to achieve diversification, as
demonstrated by Campbell, Lettau, Malkiel and Xu (2001), have special
significance to institutional investors who are known to be attracted to the more
volatile stocks (Sias, 1996; Haugen, 2002). Sias observes that,
accounting for capitalization differences, larger betas and larger residual
variances are both associated with greater institutional holdings of stocks. These
findings are supported by Falkenstein (1996) who finds that mutual funds generally
prefer the larger stocks with high visibility and are averse to stocks with low
idiosyncratic risk. Falkenstein argues that mutual funds are not driven by
conventional proxies for risk and that idiosyncratic risk, rather than beta, is a
significant factor in explaining stock holdings of mutual funds. Moreover,
Lakonishok, Shleifer, and Vishny (1994) find that individuals and institutional
investors prefer stocks of glamorous firms with high P/B ratios. Furthermore,
based on Fortune Magazine’s annual survey of company reputation, Shefrin
and Statman (1995) find that financial analysts, senior corporate executives and
outside directors rank companies as if they believe that good companies are

37
companies with high P/B ratios, and that good stocks are stocks of well run,
highly visible companies. They also rank stocks as if they are indifferent to beta.
Consistent with the CAPM and inconsistent with several studies of stock returns, I
find no significant linear relation between mutual fund returns and undiversified-
idiosyncratic risk, even though idiosyncratic variance is approximately 45% of
the average fund s variability of returns from 1992 to 2001. Instead, the study
finds a significant nonlinear relation between returns and idiosyncratic risk.
Suggestive of economies of scale, my results show a positive linear relation
between returns and fund size after controlling for the effects of portfolio beta.
Furthermore, the study finds a negative linear relation between returns and P/B
ratio after controlling for the effects of beta, and it finds no significant linear relation
between returns and either the P/E ratio or market capitalization of companies held by
mutual funds.

38
CHAPTER 3
METHODOLOGY

39
Methodology
Since no prior Consumer Behaviour studies with a holistic focus on the mutual
fund market were available, all Likert-scales had to be developed for this study.
Most consumers buy mutual funds as a means to some other goal (retirement, house,
vacation, etc.). Thus, they do not consume mutual funds in the same sense that other
products and services are consumed.
Expertise must be considered and accurately measured in ways that are task-
relevant (Alba and Hutchinson, 1987). In this study expertise was measured by five
variables: perception of own knowledge (subjective knowledge; SUBJ), frequency of
information search, i.e., how often the stock market was monitored (FREQ), access to
information and stock market analyses in six leading business magazines (INFO),
perceived ability to make own analyses of the stock market (EVAL), and perceived
ability to interpret annual reports (ANREP). Familiarity was operationalized as
respondents’ experience with the MF&S market in terms of own investments
and how long they had been investors. People who have invested in MF&S for
many years and who have a larger share of their savings in MF&S would by this
definition be likely to have more familiarity with the stock market. It was for example
assumed that the longer consumers have invested in the stock market, the more
tolerance they will have for the volatility in the market. Familiarity was
measured by three variables: percentage of total savings in MF&S (SAVE%), MF&S
as a percentage of annual income (INC%), and how many years the respondent
had owned MF&S (YEARS). Consumers who invest in MF&S have decided to
risk their money by investing in products that by nature are risky. Thus, they do not
avoid risk as such, although they may be more or less willing to take high risks on the
stock market. Risk Willingness was operationalized as willingness to take risks on the
stock market (RISK), feelings of uncertainty having made decisions (CERT), how
long they wait to sell a fund that decrease in value (WAIT), and what percentage of
total savings that they have in MF&S (SAVE%). The more they invest in the stock
market, the higher risk they take. SAVE% is also included in the Familiarity construct,
since a higher share of MF&S also results in a more varied experience of MF&S. The
two remaining concepts in the proposed model, enduring involvement (INVOLV),
and relative success or return on investments (RETURN) were measured by

40
single variables, which were used as manifest variables in the model. Enduring
involvement i.e., owners of MF&S.
Expertise must be considered and accurately measured in ways that are task-
relevant (Alba and Hutchinson, 1987). In this study expertise was measured by five
variables: perception of own knowledge (subjective knowledge; SUBJ), frequency of
information search, i.e., how often the stock market was monitored (FREQ), access to
information and stock market analyses in six leading business magazines (INFO),
perceived ability to make own analyses of the stock market (EVAL), and perceived
ability to interpret annual reports (ANREP). Familiarity was operationalized as
respondents’ experience with the MF&S market in terms of own investments
and how long they had been investors. People who have invested in MF&S for
many years and who have a larger share of their savings in MF&S would by this
definition be likely to have more familiarity with the stock market. It was for example
assumed that the longer consumers have invested in the stock market, the more
tolerance they will have for the volatility in the market. Familiarity was
measured by three variables: percentage of total savings in MF&S (SAVE%), MF&S
as a percentage of annual income (INC%), and how many years the respondent
had owned MF&S (YEARS). Consumers who invest in MF&S have decided to
risk their money by investing in products that by nature are risky. Thus, they do not
avoid risk as such, although they may be more or less willing to take high risks on the
stock market. Risk Willingness was operationalized as willingness to take risks on the
stock market (RISK), feelings of uncertainty having made decisions (CERT), how
long they wait to sell a fund that decrease in value (WAIT), and what percentage of
total savings that they have in MF&S (SAVE%). The more they invest in the stock
market, the higher risk they take. SAVE% is also included in the Familiarity construct,
since a higher share of MF&S also results in a more varied experience of MF&S. The
two remaining concepts in the proposed model, enduring involvement (INVOLV),
and relative success or return on investments (RETURN) were measured by
single variables, which were used as manifest variables in the model. Enduring
involvement exists when someone shows interest in an activity or in products over a
long period of time (Hoyer and MacInnis, 2001: 56). Consumers are motivated
to invest in MF&S for the potential returns they may get from such
investments, but the majority of them lack the ability and opportunity to
select and process the information required for making informed decisions.

41
Financial returns was operationalized as consumers’ evaluations of how

successful they have been compared with index. Consumers are familiar
with index comparisons from advertising, from articles in newspapers and
magazines, as well as in information from fund companies. There are several
reasons why this type of measure was chosen, although a more precise and
reliable measure had been highly preferable if such a measure exists. One reason
is that this is the measure with which most consumers are familiar. Another
reason is that an increase by 10% in a year when the index increased by 40% is a very
poor result. Similarly, a decrease by 5% a year when the index decreased by
60% is a very good result. It would also be unreasonable to expect that
respondents would take the time or be willing to provide detailed information about
their returns in a survey. Other measures would encounter a myriad of
problems such as defining whether returns had to be realized
or not, how to consider tax effects, etc. The design of the study was also adapted to
low involvement, inexperienced investors, due to the fact that the majority of
consumers belong to this group. The aim was therefore to use as few variables
as possible in the study and to focus more on the holistic approach than on the details.
Frequency analyses showed that 19% of respondents had a high or very high
subjective knowledge (SUBJ). A relevant question in this study is whether it is
possible to have realistic expectations about the stock market if you know very
little about it. Respondents were asked—in a follow-up question to the self-
Beta
Definition:A quantitative measure of the volatility of a given stock, mutual fund, or

portfolio, relative to the overall market, usually the S&P 500. Specifically, the
performance the stock, fund or portfolio has experienced in the last 5 years as the
S&P moved 1% up or down. A beta above 1 is more volatile than the overall market,
while a beta below 1 is less volatile.
Risk
Definition: Risk is the chance that an investment’s actual return will be different than
expected. This includes the possibility of losing some or all of the original investment.

42
It is usually measured by calculating the standard deviation of the historical returns or

average returns of a specific investment. A fundamental idea in finance is the
relationship between risk and return. The greater the amount of risk that an investor is
willing to take on, the greater the potential return. The reason for this is that investors
need to be compensated for taking on additional risk.
For each fund, Morningstar offers two sets of data to help investors get a sense of the
risk of owning a particular fund
Volatility Measurements:
• Mean
• Standard Deviation
• Sharpe Ratio
• Bear Market Decile Rank
Modern Portfolio Theory Statistics:
• R-Squared
• Beta
• Alpha
Mean is the mathematical average of a set of data. If, for example, a stock XYZ’s
annual return in the past three years are 10%, 5% and 15%, respectively, then the
arithmetic mean of the stock’s return is 10%, the average 10%, 5% and 15%. Once
the mean is known, we can calculate stock XYZ’s standard deviation , which
measures the dispersion of the stock’s annual returns (i.e., 10%, 5% and 15%)
from the mean expected return (10%). Therefore, the further away an equity’s
annual return from the mean, the higher the standard deviation. In finance,
standard deviation is used to gauge an equity’s volatility, whether the equity is a
stock or a mutual fund.
During the recent market sell-off, the majority of stocks followed the movement of
the general market and turned lower, the only difference among stocks is the extent of
the downturn as compared to the benchmark. The risk that a stock tends to go along
with the general market is captured by beta, also known as systematic risk (or market

43
risk), which measure how an individual stock or fund reacts to the general market
fluctuations. By definition, a benchmark (or index) has a beta of 1.00 and the beta of
an equity is relative to this value. If the movement of a stock or fund can be
completely explained by the movements of the general market, then this stock or fund
will have a R-squared of 100. According to Morningstar, R-squared, represented by a
percentage number ranging from 0 to 100, characterizes an equity’s movement against
a benchmark. A R-squared that equals to 100 means all the equity’s movements are in-
line with the benchmark.
With the Greek letter beta, investors can have an sense of how sensitive an equity is in
relation to the broad market. If investors decide to take on a higher risk by investing
in a volatile equity that carries a larger beta, then in theory, they should be rewarded
with a higher than average return. The difference between the realized return and the
average expected return is measured by another Greek letter alpha. A positive alpha
indicates that the equity exceeds its expectations against the respective benchmark.
How they work
Now we know what the risk measurements are, let’s see how we can use them to
assess the risk/reward of an investment.
To illustrate, I use two funds, Dodge & Cox Stock Fund (DODGX) and CGM Focus
Fund (CGMFX), that I own to show how they are measured up against each other in
each category. Using S&P 500 index as the benchmark, the performance and risk data
of the two funds are shown in the following table (obtained from Morningstar.com,
trailing 3-year data through February 28, 2007):
Funds 2004 2005 2006 Mean STD R-squared Beta Alpha

DODGX 19.2 9.4 18.5 13.76 7.46 86 0.98 4.16
CGMFX 12.3 25.4 15.0 19.42 20.32 19 1.26 7.45
• Mean: The mean represents the annualized average monthly return. Therefore,
a higher mean suggests a higher return the fund has delivered. In this case,
CGMFX has a superior average return of 19.46.

44
• Standard deviation (STD): Though CGMFX has a higher average return, this
fund is by no means less volatile, which is indicated by its much higher STD
(20.32) than DODGX’s 7.46.
• R-squared: If we recall that R-squared measures a fund’s movement against
the benchmark and a value close to 100 means the fund follows the benchmark
very closely. Also, R-squared can help investor assess the usefulness of a
fund’s beta or alpha statistics. A higher R-squared means the fund’s beta is
more trustworthy. In this case, CGMFX’s 19 R-squared value says that only
19% of its movements can be explained by the fluctuations of S&P 500 index,
an ill-fitted benchmark for CGMFX (indeed, Morningstar points that the best
fit index for CGMFX is the Goldman Sachs Natural Resources index, which
will give the fund a R-squared value of 80). On the other hand, DODGX’s 86
R-squared value indicates the fund is well represented by S&P 500 and its beta
value can be trusted.
• Beta: Now we know S&P 500 is not a good benchmark for CGMFX, its beta
value, though higher, is not particularly helpful in assessing the fund’s risk in
comparison to the benchmark. Generally, beta measures a fund’s risk
associated with the market and a low beta only means that the funds market-
related risk is low. For DODGX, a beta value of 0.98 tells us that the fund has
performed 2% worse than S&P 500 index (beta equals to 1.00) in up markets
and 2% better in down markets.
• Alpha: With a R-square value that we can trust, beta can be used to predict the
fund’s expected return and alpha is the yardstick for the difference between a
fund’s actual return and the predication. A large, positive alpha then means a
fund has performed better than what its beta would predict. For DODGX, its
alpha of 4.16 means the fund has outperformed the benchmark (S&P 500
index) by 4.16% (according to Morningstar data, DODGX has indeed
outperformed S&P 500 by 4.41% in the 3-year annualized total return
category).
The management objectives of a particular mutual fund, to a large extent,

determine the risk and return structure of the fund's portfolio. Thus, if funds are
grouped by objectives such as growth or income, it is expected that risk will be

45
homogeneous within those mutual fund groups and adjustment for risk is then
redundant. The main thrust of this research is to
(1) test for homogeneity of risk within and between fund groups within and
between time periods and
(2) attempt to develop a new composite risk-return index for use in comparing
the performance of funds with different objectives.
Risk homogeneity was investigated for two risk proxies: the standard deviation
of return (Sharpe) and the beta value (Treynor). One time period was taken from
May 2008 to June 2008. Mutual fund objectives were derived from
Wiesenberger's publication and funds were classified into four groups: growth,
growth-income, income and Gold funds. The results obtained from testing the
standard deviations of return are: a) the hypothesis of a within-group
homogeneous standard deviation of return is rejected during the time period,
b) standard deviations of return are different between subgroups; c) standard
deviations within fund groups have grown more similar over time; d) significant
positive rank correlation over time occurs when fund types were mixed;
however, the within group correlation between the ranks of the individual funds
is not significant over time. The following results are obtained by testing the
homogeneity of beta values: a) the beta coefficients of mutual fund subgroups do
not significantly differ from the average beta coefficient. Income funds during
one of the two time periods investigated for this fund type provide the only
definite exception to this conclusion; b) all mutual fund groups combined
display only one average beta value during the time period; during the period
the growth and growth-income funds do not significantly differ from their
average beta value. Thus, two distinct mutual fund groups can be formed
(income funds are not investigated for that particular period); during the time
period four distinct fund groups evolve; c) a majority of the beta values for
individual funds are stable over time, whereas stability of average beta values
of fund groups over time is not found.
The interpretation of the empirical tests of the risk proxies lend credence to the
basic hypothesis that (1) homogeneous risk groups of funds with similar
objectives do exist, and (2) it is preferable to assume that risk as measured by

46
the above proxies is generally found to be heterogeneous for fund types with
different objectives. The generally made assumption of stability of risk over time for
portfolios (average beta values) is maintained. These findings lead to a new
ranking procedure computing each fund's performance by its average arithmetic
return above the risk free rate divided by the weighted average beta coefficient
of the fund's particular risk group. Correlation of this new ranking procedure
with the performance measures of Sharpe and Treynor is shown to be
significant; Jensen's measure of performance is not significantly correlated with this
new ranking procedure.
BETA, Risk and Mutual Funds

Every investment involves risk, and it's important to determine how much risk is
appropriate for any fund that you are considering. Risk means making less than your
planned return or even losing capital
Although not exactly ideal, the standard deviation (dispersion around the mean return)
is generally accepted as a measure of risk. Unlike the standard deviation, Beta
measures the volatility of a fund relative to a benchmark index. Funds of the same
type can have significantly different levels of risks. Fund-rating services such as
Morningstar and Value Line rank risk in terms of Beta, a measurement of how volatile
a fund is in comparison to a benchmark market indicator, such as the Standard &
Poor's 500-stock index. A fund with a Beta of higher than 1.0 (1.0 = the benchmark
index) would be expected to outperform the market, while one below that figure
would likely underperform. But a Beta of greater than 1.0 also means the fund is
volatile. In bear markets, the value of these funds may fall much more than the major
market indexes. Beta, a component of Modern Portfolio Theory statistics, is a
measure of a fund's sensitivity to market movements. It measures the relationship
between a fund's excess return over T-bills and the excess return of the benchmark
index.
By definition, the Beta of the market benchmark (in this case, an index) is 1.00.
Accordingly, a fund with a 1.10 Beta has performed 10% better than its benchmark
index--after deducting the T-bill rate--than the index in up markets and 10% worse in
down markets, assuming all other factors remain constant. Conversely, a Beta of
0.85 indicates that the fund has performed 15% worse than the index in up markets

47
and 15% better in down markets. The Beta calculation involves a bit of math, but the
resulting number is very easy to understand.
Beta is only indicative for funds with a relatively high correlation with the index.
In other words, the higher R-Squared is, the more relevant the fund's Beta.
The Beta Calculation Process

Here is an example showing the inner details of the Beta calculation process:
Suppose we collected end-of-the-month prices and any dividends for a stock and the
S&P/TSX index for 36 months (0..36). We need n + 1 price observations to calculate
n holding period returns, so since we would like to index the returns as 1...36, the
prices are indexed 0.... 36. Also, professional Beta services use monthly data over a
36-month period.
Now, calculate monthly holding period returns using the prices and dividends. For
example, the return for month 2 will be calculated as: r_2 = ( p_2 - p_1 + d_2 ) / p_1
Here r denotes return, p denotes price, and d denotes dividend. The following table of
monthly data may help in visualizing the process.
(Monthly data is preferred in the profession because investors' horizons are said to be
monthly.)
Nr. Date Price Div. (*) Return

0 12/31/86 45.20 0.00 --
1 01/31/87 47.00 0.00 0.0398
2 02/28/87 46.75 0.30 0.0011
. ... ... ... ...
35 11/30/91 46.75 0.30 0.0011
36 12/31/91 48.00 0.00 0.0267
(*) Dividend refers to the dividend paid during the period. They are assumed to be
paid on the date. For example, the dividend of 0.30 could have been paid between
02/01/87 and 02/28/87, but is assumed to be paid on 02/28/87. So now, we'll have a
series of 36 returns on the security and the index (1….36). Plot the returns on a graph
and fit the best-fit line (using the least squares regression curve fitting process):
Modern Portfolio Theory-the underpinning

48
Risk is composed of systematic (market risk) and unsystematic risk (company-

specific). Systematic risk includes currency risks, inflation risks, foreign investment
risk, political and regulatory risks, interest rate risk, economic risks, and lately
terrorist risk. Even bad weather risk can affect certain market sectors such as retailers,
agriculture, forest products, insurance, airlines and tourism. Systematic risk cannot be
eliminated by diversification within a given market. Systematic risk captures the
reaction of individual stocks or portfolios to general market swings. Some stocks and
portfolios tend to be very sensitive to market movements. Others are more stable.
This relative volatility or sensitivity to market moves can be estimated on the basis of
the past record, and is popularly denoted by Beta. Beta is the numerical description of
systematic risk. Despite the mathematical manipulations involved, the basic idea
behind the Beta measurement is one of putting some precise numbers on the
subjective feelings money managers have had for years. Beta is essentially a
comparison between the movements of individual stocks (or portfolios) and the
movements of the market as a whole. Professionals often call high- Beta stocks
aggressive investments and label low- Beta stocks as defensive investments. The Beta
of a portfolio is the weighted average of the Betas of individual securities making up
the portfolio.
Modern Portfolio Theory says that the total risk of each individual security is
irrelevant. It is only the systematic component that counts as far as extra rewards go.
Because stocks (30 or more at least) can be combined in portfolios to eliminate or
reduce specific (unsystematic) risk, only the undiversifiable or systematic risks will
command a risk premium. Investors will not get rewarded for bearing risks that can
be diversified away. This is the basic logic behind the Capital Asset Pricing Model
(CAPM), which itself is a very simplified model.
The logic behind it is as follows:

If investors did get an extra return / risk premium for bearing unsystematic risk it
would turn out that the diversified portfolios made up of stocks with large amounts of
unsystematic risk would give larger returns than equally risky portfolios of stocks
with less unsystematic risk. Investors would jump at the chance to have these higher
returns, bidding up the prices of stocks with large unsystematic risk and selling stocks
with equivalent Betas but lower unsystematic risk. This process would continue until

49
the prospective returns of stocks with the same Betas were equalized and no risk
premium could be obtained for bearing unsystematic risk. Any other results would be
inconsistent with the existence of an efficient market.
Mathematically Beta is defined as: Beta=COV (RF, RM) / VAR (RM)

where COV is the covariance between RF and RM
RF =the return of the mutual fund
RM=the return of the index
VAR (RM)=the variance of the index
VAR-the variance is the square of the standard deviation usually denoted by the Greek
letter Sigma
Covariance is defined as COV (X, Y)=E [(X-µx)(Y-µY)] and measures the direction
and strength of the relationship between random variables X and Y where E is the
expected value and =the population mean. If X and Y are statistically independent
(no relationship) than E (X*Y)=E (X)*E (Y). Beta is a dimensionless number.
Dividing the covariance by the benchmark variance merely normalizes the measure of
Beta.
Another equivalent, but perhaps more intuitive definition of Beta is:
fl = Correlation (Fund, Market) x Std Dev (F) / Std Dev (M)
Beta values can be roughly characterized as follows:
* Beta less than 0
Negative Beta is possible but not likely. People thought gold
stocks should have negative Betas but that hasn't been true.
* Beta equal to 0
Cash under your mattress, assuming no inflation
* Beta between 0 and 1
Low-volatility investments (e.g., utility stocks)
* Beta equal to 1
Matching the index (e.g., for the S&P 500, a U.S. index fund, in Canada an Index ETF
like i60; TSX: XIU. XIU which mirrors the S&P/TSX 60, has a turnover of about 13
% to remain congruent with it’s index changes
* Beta greater than 1
Anything more volatile than the index (e.g., small cap. funds)
* Beta much greater than 1 (tending toward infinity)

50
Impossible, because the stock would be expected to go to zero on any market decline.
It has been shown that Betas are approximately normally distributed with a standard
deviation of around 0.3. Hence, about 95 percent of shares have Betas which lie
between 0.4 and 1.6.
High Beta funds are expected to do better than the market. During declines they are
expected to do worse than the market average. Betas are not stable from period to
period), and they are very sensitive to the particular market proxy/ benchmark against
which they are measured (the S&P 500 itself has a annual turnover of about 8 % due
to changes and mergers/divestitures). The choice of index is huge for obvious reasons.
There is only a handful of Canadian equity funds that truly deserve to be
benchmarked to a 100% TSX Composite Index. Most have at least 10% foreign
content, with many at 20%+. Also, some U.S. equity funds (i.e. Janus American
Equity, Spectrum American Growth, and Templeton Mutual Beacon to name a few)
have a mandate to hold a certain
amount in overseas stocks. Benchmarking a fund seems a difficult task since few
funds offer pure exposure to a single market/ asset class.
Meaning of Beta
A lot of disservice has been done to Beta in the popular press because of trying to
oversimplify the concept. A Beta of 1.5 does not mean that if the market goes up by
10 points, the stock (or fund) will go up by 15 points. It also doesn't mean that if the
market has a return (over some period, say a month) of 2%, the stock will have a
return of 3%. To understand Beta, look at the equation of the line representing the
best fit using the least squares linear regression technique:
stock return = alpha + Beta * index return+ epsilon where epsilon is a random error
term
Beta indicates the average sensitivity of an individual security to the market return,
and is a measure of the market or systematic risk of a security (or portfolio). As the
coordinates do not fall exactly on the line of best fit, an error term, epsilon, is
introduced to represent the unexplained security return. The specific returns arise
because of events affecting the economy, and are represented by alpha as well as

51
epsilon. Alpha represents on average, the portion of a security’s return that is not
associated with general movements in the economy. Alpha therefore represents the
average return of an individual security when the return of the market index is zero. It
is taken to be equal to the risk-free rate i.e. T-bill rate.
One shot at interpreting Beta is the following. On a day the (S&P-type) market index
goes up by 1%, a stock with a Beta of 1.5 will go up by 1.5% + epsilon (can be
positive or negative). Thus it won't go up by exactly 1.5%, but by something
different.
The good thing is that the epsilon values for different stocks are guaranteed to be
uncorrelated with each other. Hence in a diversified portfolio , you can expect all the
epsilons (of different stocks) to cancel out. Thus if you hold a diversified portfolio,
the Beta of a stock characterizes that stock's response to fluctuations in the market
index.
So in a diversified portfolio like a mutual fund, the Beta of a fund is a not an
unreasonable summary of its risk properties with respect to the "systematic risk",
which is fluctuations in the market index. A fund or stock with high Beta responds
strongly to variations in the market, and a fund or stock with low Beta is relatively
insensitive to variations in the market.
The main practical problem in applying the Markowitz approach to portfolio
management is the large amounts of data which is required. The calculation of Beta
makes it necessary to estimate how returns of every individual security would move
or “covary” with those of every other individual security.
With a view to simplifying the computations and reducing the quantity of data
required for the Markowitz approach, Dr. William Sharpe and others side-stepped the
difficult task of estimating covariances between all securities. This was achieved by
including risk-free securities in the analysis, identifying the market portfolio on the
Markowitz efficient frontier and generating a market sensitivity measure (Beta) for
each security. Without going into all the details, this results in the equation E (RF)=
alpha + E (RM - alpha)] which from our Grade 11 math is a straight line with
slope Beta and Y intercept alpha. In plain English this means that the expected Return
of the fund is =to the risk-free rate, say a GIC or T–bill, plus Beta times the expected
return of the market index less the risk-free return. So, Beta can be a useful tool in
assessing the risk/reward appropriateness of a fund.

52
So, if the market return is 2% above the risk-free rate , the stock return would on
average be 3% above the risk-free rate, if the stock Beta is 1.5.
Using Beta
Current Government regulations do not require Fund Companies to publish the value
of Beta in the Prospectus. They only publish return data, portfolio turnover % and the
MER so you’ll have to phone the Company for the data. Expect some pain, as
customer service people don’t get this type of question every day.
In general, Beta values are a useful way of determining how a mutual fund has done,
and how well it may do from a risk perspective in the future. Beta values for many
U.S. mutual funds can be found in financial magazines or special investing periodicals
such as Investor's Business Daily. In Canada, it’s best to phone the fund Company or
use www.globefund.com or equivalent web-site. Filtering on Beta is not provided so
you’ll have to do some trial and error to find the fund that fits the Beta that’s right for
you.
A conservative investor whose main concern is preservation of capital should focus on

funds with low Betas, whereas one willing to take high risks in an effort to earn high
rewards should look for high-Beta funds. Some funds go better together than others.
You do not diversify if you buy two funds that have a history of moving up and down
at the same time. Also,never forget your personal financial goals and risk tolerance.
If you had a portfolio of Beta 1.2, and decided to add a fund or stock with Beta 1.5,
then you know that you are slightly increasing the riskiness (and potential average
return) of your portfolio. This conclusion is reached by merely comparing two
numbers (1.2 and 1.5). That parsimony of computation is the major contribution of
the notion of "Beta". Conversely if you got cold feet about the variability of your Beta
= 1.2 portfolio, you could augment it with a few companies with Beta less than 1.The
Beta of a portfolio is the dollar -weighted average of the securities held in the
portfolio (i.e. mutual fund) relative to a given market.
NAVs
World Gold
Scheme Name Fund

53
From Date 1-Jan-08

To Date 30-Jun-08
Date NAV (Rs.) Daily Return in

%
2-May-08 13.3289
3-May-08 13.423 0.706
4-May-08 13.548 0.931
5-May-08 13.8429 2.177
6-May-08 13.8429 0.000
7-May-08 14.0419 1.438
8-May-08 14.3253 2.018
9-May-08 14.2723 -0.370
13-May-08 14.2251 -0.331
14-May-08 14.3339 0.765
15-May-08 14.5322 1.383
16-May-08 15.0879 3.824
20-May-08 15.4151 2.169
21-May-08 15.789 2.426
22-May-08 15.8423 0.338
23-May-08 15.6457 -1.241
23-May-08 15.6457 0.000
26-May-08 15.3331 -1.998
27-May-08 15.1992 -0.873
28-May-08 15.0135 -1.222
29-May-08 14.9386 -0.499
30-May-08 14.8216 -0.783
2-Jun-08 14.797 -0.166
3-Jun-08 14.8768 0.539
4-Jun-08 14.6713 -1.381
5-Jun-08 14.5863 -0.579
6-Jun-08 14.791 1.403
9-Jun-08 14.7667 -0.164
10-Jun-08 14.4802 -1.940
11-Jun-08 14.1372 -2.369
12-Jun-08 13.6954 -3.125
13-Jun-08 13.7225 0.198
16-Jun-08 13.9544 1.690
17-Jun-08 14.049 0.678
18-Jun-08 14.0671 0.129
19-Jun-08 14.2497 1.298
20-Jun-08 14.1242 -0.881
24-Jun-08 14.014 -0.780
25-Jun-08 13.8426 -1.223
26-Jun-08 14.1363 2.122
27-Jun-08 14.7264 4.174
30-Jun-08 15.014 1.953
average 0.303
sdt. Dev. 1.601

54
DSP ML World Gold Fund

16.5
16
15.5
15
14.5
NAV
14
13.5
13
12.5
12
8
8
08
08
08
00
00
00
00
00
00
20
20
20
/2
/2
/2
/2
/2
/2
8/
4/
1/
11
18
25
15
22
29
5/
6/
6/
5/
5/
5/
6/
6/
6/
NAVs from May to June 2008
NAVs
Scheme Name Top 100 Equity Fund - Reg
From Date 1-May-08
To Date 30-Jun-08
%
2-May-08 78.417
3-May-08 78.234 -0.233
4-May-08 78.017 -0.277
5-May-08 77.916 -0.129
6-May-08 77.406 -0.655
7-May-08 77.253 -0.198
8-May-08 76.431 -1.064
9-May-08 75.239 -1.560
12-May-08 75.623 0.510
13-May-08 75.025 -0.791
14-May-08 75.753 0.970
15-May-08 76.846 1.443
16-May-08 77.43 0.760
20-May-08 76.94 -0.633
21-May-08 76.809 -0.170
22-May-08 75.82 -1.288
23-May-08 75.129 -0.911
26-May-08 74.207 -1.227
27-May-08 74.059 -0.199
28-May-08 74.97 1.230
29-May-08 74.539 -0.575
30-May-08 75.111 0.767
2-Jun-08 73.755 -1.805
3-Jun-08 73.189 -0.767

55
4-Jun-08 71.466 -2.354

5-Jun-08 72.616 1.609
6-Jun-08 71.867 -1.031
9-Jun-08 70.109 -2.446
10-Jun-08 69.63 -0.683
11-Jun-08 70.369 1.061
12-Jun-08 70.608 0.340
13-Jun-08 70.474 -0.190
16-Jun-08 71.174 0.993
17-Jun-08 72.131 1.345
18-Jun-08 71.241 -1.234
19-Jun-08 70.287 -1.339
20-Jun-08 68.321 -2.797
23-Jun-08 67.236 -1.588
24-Jun-08 66.059 -1.751
25-Jun-08 66.433 0.566
26-Jun-08 66.953 0.783
27-Jun-08 64.897 -3.071
30-Jun-08 63.86 -1.598
average -0.481
std. dev. 1.200
DSP ML Top 100 Equity - Reg

90
80
70
60
NAV(Rs)
50
40
30
20
10
0
08
08
08
8
8
8
8
00
00
00
00
00
00
20
20
20
/2
/2
/2
/2
/2
/2
2/
9/
6/
16
23
30
13
20
27
5/
5/
6/
5/
5/
5/
6/
6/
6/
Daily NAVs for May and June 08
NAVs
Scheme Name Govt Sec. Fund - Plan A
From Date 1-Jan-08
To Date 30-Jun-08
Date NAV (Rs.) Daily Return in %

56
2-May-08 25.1042
3-May-08 25.1125 0.033
4-May-08 25.154 0.165
5-May-08 25.169 0.060
6-May-08 25.1383 -0.122
7-May-08 25.0788 -0.237
8-May-08 25.0639 -0.059
9-May-08 25.0531 -0.043
12-May-08 25.1763 0.492
13-May-08 25.1531 -0.092
14-May-08 25.1492 -0.016
15-May-08 25.0999 -0.196
16-May-08 25.0372 -0.250
20-May-08 25.032 -0.021
21-May-08 24.9777 -0.217
22-May-08 24.9473 -0.122
23-May-08 24.8951 -0.209
26-May-08 24.9211 0.104
27-May-08 24.8163 -0.421
28-May-08 24.8802 0.257
29-May-08 24.8476 -0.131
30-May-08 24.8522 0.019
2-Jun-08 24.8719 0.079
3-Jun-08 24.8471 -0.100
4-Jun-08 24.8288 -0.074
5-Jun-08 24.8225 -0.025
6-Jun-08 24.8165 -0.024
9-Jun-08 24.823 0.026
10-Jun-08 24.8178 -0.021
11-Jun-08 24.8443 0.107
12-Jun-08 24.7969 -0.191
13-Jun-08 24.7334 -0.256
16-Jun-08 24.7732 0.161
17-Jun-08 24.8141 0.165
18-Jun-08 24.788 -0.105
19-Jun-08 24.7054 -0.333
20-Jun-08 24.5819 -0.500
23-Jun-08 24.5876 0.023
24-Jun-08 24.6389 0.209
25-Jun-08 24.5647 -0.301
26-Jun-08 24.5668 0.009
27-Jun-08 24.5688 0.008
30-Jun-08 24.5795 0.044
average -0.050
std. dev. 0.187

57
DSP ML Govt Sec. Fund - Plan A
25.3
25.2
25.1
25
24.9
24.8
NAV
24.7
24.6
24.5
24.4
24.3
24.2
08
08
08
08
8
8
00
00
00
00
00
0
20
20
20
/2
/2
/2
/2
/2
/2
2/
9/
6/
16
23
30
20
27
13
5/
5/
6/
5/
5/
5/
6/
6/
6/
NAVs form May to June 2008
NAVs
Scheme Name Tax Saver Fund
From Date 1-Jan-08
To Date 30-Jun-08

%
2-May-08 14.06
5-May-08 14.109 0.349
6-May-08 13.95 -1.127
7-May-08 13.987 0.265
8-May-08 13.891 -0.686
9-May-08 13.577 -2.260
12-May-08 13.56 -0.125
13-May-08 13.508 -0.383
14-May-08 13.637 0.955
15-May-08 13.889 1.848
16-May-08 14.059 1.224
20-May-08 13.988 -0.505
21-May-08 14.106 0.844
22-May-08 13.947 -1.127
23-May-08 13.738 -1.499
26-May-08 13.454 -2.067
27-May-08 13.369 -0.632
28-May-08 13.49 0.905

58
29-May-08 13.39 -0.741

30-May-08 13.428 0.284
2-Jun-08 13.172 -1.906
3-Jun-08 13.048 -0.941
4-Jun-08 12.705 -2.629
5-Jun-08 12.872 1.314
6-Jun-08 12.747 -0.971
9-Jun-08 12.404 -2.691
10-Jun-08 12.337 -0.540
11-Jun-08 12.451 0.924
12-Jun-08 12.547 0.771
13-Jun-08 12.581 0.271
16-Jun-08 12.649 0.540
17-Jun-08 12.834 1.463
18-Jun-08 12.705 -1.005
19-Jun-08 12.494 -1.661
20-Jun-08 12.109 -3.081
23-Jun-08 11.803 -2.527
24-Jun-08 11.612 -1.618
25-Jun-08 11.774 1.395
26-Jun-08 11.824 0.425
27-Jun-08 11.506 -2.689
30-Jun-08 11.302 -1.773
average -0.535
std. dev. 1.364
DSP ML Tax Saver Fund

16
14
12
10
NAV
8
6
0
08
08
08
8
8
8
00
00
00
00
00
00
20
20
20
/2
/2
/2
/2
/2
/2
2/
6/
9/
16
30
13
20
27
23
5/
5/
6/
5/
5/
5/
6/
6/
6/
NAVs from May to June 2008
DSP Merrill Lynch World Gold Fund – Growth Fund Facts
Objective

59
The primary investment objective of the Scheme is to seek capital appreciation

by investing predominantly in units of MLIIF - WGF. The Scheme may, at the
discretion of the Investment Manager, also invest in the units of other similar
overseas mutual fund schemes, which may constitute a significant part of its
corpus. The Scheme may also invest a certain portion of its corpus in money
market securities and/or units of money market/liquid schemes of DSP Merrill
Lynch Mutual Fund, in order to meet liquidity requirements from time to time.
However, there is no assurance that the investment objective of the Scheme will
be realized.
Type of Scheme Open Ended Dhawal Dalal,

Nature Fund of Funds Fund Manager Aniruddha Naha
Option Growth .
Inception Date Aug 23, 2007 SIP
Face Value STP
10
(Rs/Unit) SWP
Fund Size in 1906.1 as on Jul Expense
0.74
Rs. Cr. 31, 2008 ratio(%)
Portfolio
Turnover NA
Ratio(%)

60
Last Divdend
NA
Declared
Minimum
5000
Investment (Rs)
Purchase
Daily
Redemptions
NAV Calculation Daily
Amount Bet. 0 to 49999999 then Entry load is 2.25%. and
Entry Load
Amount greater than 50000000 then Entry load is 0%.
If redeemed bet. 0 Months to 6 Months; Exit load is 1%. If
Exit Load
redeemed bet. 6 Months to 12 Months; Exit load is 0.5%.
SCHEME PERFORMANCE (%) AS ON AUG 8, 2008

1 Month 3 Months 6 Months 1 Year 3 Years 5 Years Since
Inception
-20.64 -22.11 -19.81 NA NA NA 12.92
Mean 0.303 Treynor NA

Standard 1.601 Sortino NA
Deviation Correlation NA
Sharpe NA Fama NA
Beta NA
DSP MERRILL LYNCH WORLD GOLD FUND - GROWTH

61
Fund Size as on Jul 31, 2008

Fund Size ( Rs. in 1906.1
crores)
Asset Allocation as Jul 31, 2008
on
Equity 0%
Debt 1.42%
Others 98.58%
TOP 10 HOLDING AS ON JUN 30, 2008
DEBT
Company Name Instrument Rating Market Percentage
Value of Net
(Rs. in Assets
crores)
DSP Merril Lynch Liquid Plus MFDebt 26.79 1.3
Fund - Institutional Plan -
Growth
OTHERS
Company Name Instrument Market % of
Value (Rs. Net
in crores) Assets
GOLD - BULLION Gold 2,041.09 98.96
CBLO Money Market 13.00 0.63
Net Receivables/(Payable) Net -18.43 -0.89
Receivables/(Payables)
DSP Merrill Lynch

World Gold Fund –
Growth

62
BSE
Sensex
BSE
METAL
DSP Merrill Lynch Top 100 Equity Fund – Growth
Fund Facts
objective
The Fund is seeking to generate capital appreciation, from a portfolio that is

substantially constituted of equity and equity related securities of the 100 largest
corporates, by market capitalisation, listed in India.
Type of Scheme Open Ended Fund Manager Apoorva Shah .

Nature Equity SIP
Option Growth STP
Inception Date Feb 21, 2003 SWP
Face Value Expense
10 2.13
(Rs/Unit) ratio(%)
Fund Size in 957.56 as on Jul Portfolio
Rs. Cr. 31, 2008 Turnover 389.4
Ratio(%)

63
Last Divdend
NA
Declared
Minimum
5000
Investment (Rs)
Purchase Daily
Redemptions
Entry Load Amount Bet. 0 to 49999999 then Entry load is 2.25%. and
Exit Load If redeemed bet. 0 Months to 6 Months; Exit load is 1%. If
redeemed bet. 6 Months to 12 Months; Exit load is 0.5%.

Inception
10.95 -8.40 -8.30 4.50 31.35 38.25 43.21
Mean 1.07 Treynor 1.09

Standard 3.30 Sortino 0.47
Deviation Correlation 0.88
Sharpe 0.29 Fama 0.22
Beta 0.88
Portfolio Attribites

64
23.56 as on Jun -
P/E
2008
7.40 as on Jun -
P/B
2008
1.23 as on Jun -
Dividend Yield
2008
Market Cap (Rs. 65,481.03 as on
in crores) Jun - 2008
Large 73.01 as on Jun -
2008
Mid NA
Small NA
Top 5 Holding 29.10 as on Jun -
(%) 2008
No. of Stocks 43
Expense Ratio 2.13
(%)
Top 10 Holding

65
Percentage
Percentage
of Change
Stock Sector P/E of Net Qty Value
with last
Assets
month
Nifty Miscellaneous NA 11.49 NA 96.46 -21.14
Bharti Airtel Ltd Telecom 22.05 5.41 630,234 45.46 61.73
Engineering &
Larsen & Toubro
Industrial 33.12 4.63 178,122 38.91 -30.35
Limited
Machinery
Oil & Gas,
Reliance
Petroleum & 21.09 3.90 156,303 32.75 -34.93
Industries Ltd
Refinery
Hindustan Lever Diversified 27.50 3.66 1,484,330 30.75 16.31
Ltd
Tata Computers - 19.08 3.48 340,818 29.25 16.03
Consultancy Software &
Services Ltd. Education
Housing Finance 25.40 3.30 140,836 27.67 -35.20
Development
Finance
Corporation Ltd
Food & Dairy 3.28 168,869 27.53 5.85
Nestle India Ltd 31.35
Products
Computers -
Infosys
Software & 19.48 3.19 154,050 26.76 -39.05
Technologies Ltd
Education
Glenmark
Pharmaceuticals Pharmaceuticals 45.15 2.68 353,210 22.49 -3.42
Ltd.

66
Auto & Auto

1.52
ancilliaries
Banks 8.93
Cement 1.10
Computers - Software
4.98
& Education
Current Assets 8.78
Diversified 2.97
Electricals &
4.41
Electrical Equipments
Electronics 2.15
Engineering &
2.61
Industrial Machinery
Entertainment 2.16
Finance 7.00
Food & Dairy
2.41
Products
Housing &
2.47
Construction
Metals 0.51
Miscellaneous 16.32
Oil & Gas, Petroleum
9.86
& Refinery
Paints 0.62
Pharmaceuticals 9.60
Power Generation,
3.67
Transmission & Equip
Steel 0.11
Telecom 6.44
Textiles 1.36

67
DSP Merrill
Lynch Top 100
Equity Fund -
Growth
BSE100
BSE Sensex
DSP Merrill Lynch Government Sector Fund – Growth
Fund facts
Objective
The primary investment objective of the Scheme is to seek to generate medium

to long-term capital appreciation from a diversified portfolio that is substantially
constituted of equity and equity related securities of corporates, and to enable
investors to avail of a deduction from total income, as permitted under the
Income Tax Act, 1961 from time to time.
Type of Scheme Open Ended Anup

Fund Manager
Nature Equity Maheshwari .
Option Growth SIP
Inception Date Dec 21, 2006 STP
Face Value SWP
10
(Rs/Unit) Expense
2.36
Fund Size in 467.31 as on Jul ratio(%)
Rs. Cr. 31, 2008 Portfolio
Turnover 243.78
Ratio(%)

68
Last Divdend
NA
Declared
Minimum
500
Investment (Rs)
Purchase
Daily
Redemptions
Entry Load
Exit Load Exit Load is 0%.
Risk & return
Inception
10.43 -11.45 -17.43 -1.02 NA NA 14.23
Mean NA Treynor NA
Standard NA Sortino NA
Sharpe NA Fama NA
Beta NA
Portfolio

69
Portfolio attributes
Style Box
25.18 as on Jun -
P/E
2008
4.54 as on Jun -
P/B
2008
0.87 as on Jun -
Dividend Yield
2008
43.21 as on Jun -
Large
2008
28.82 as on Jun -
Mid
2008
9.40 as on Jun -
Small
2008
(%) 2008
No. of Stocks 87
Expense Ratio 2.36
(%)
DSP Merrill
Lynch G Sec
Fund Plan A
Long Duration
- (G)

70
CNX500
BSE Sensex
DSP Merrill Lynch Tax Saver Fund – Growth
Fund facts
Objectives
The primary investment objective of the Scheme is to seek to generate medium

to long-term capital appreciation from a diversified portfolio that is substantially
constituted of equity and equity related securities of corporates, and to enable
investors to avail of a deduction from total income, as permitted under the
Income Tax Act, 1961 from time to time.
Type of Scheme Open Ended Anup

Fund Manager
Nature Equity Maheshwari .
Option Growth SIP
Inception Date Dec 21, 2006 STP
Face Value SWP

10
(Rs/Unit) Expense
2.36
Fund Size in Rs. 467.31 as on Jul ratio(%)
Cr. 31, 2008 Portfolio
Turnover 243.78
Ratio(%)

71
Last Divdend
NA
Declared
Minimum
500
Investment (Rs)
Purchase
Daily
Redemptions
Entry Load
Exit Load Exit Load is 0%.
Risk & Return

Inception
10.43 -11.45 -17.43 -1.02 NA NA 14.23
Mean NA Treynor NA
Standard NA Sortino NA
Sharpe NA Fama NA
Beta NA
Portfolio
Portfolio attributes style box

72
25.18 as on Jun -
P/E
2008
4.54 as on Jun -
P/B
2008
0.87 as on Jun -
Dividend Yield
2008
43.21 as on Jun -
Large
2008
28.82 as on Jun -
Mid
2008
9.40 as on Jun -
Small
2008
(%) 2008
No. of Stocks 87
Expense Ratio 2.36
(%)

73
Top 10 holdings
Percentage
Percentage
of Change
Stock Sector P/E of Net Qty Value
with last
Assets
month
Dr Reddys
Laboratories Pharmaceuticals 17.33 4.02 262,399 17.58 -6.19
Ltd
Reliance
Communication Telecom 49.23 3.69 363,756 16.11 -33.28
Ventures Ltd.
Computers -
Allied Digital
Software & 29.01 2.69 144,654 11.75 -12.81
Services Ltd
Education
Divis
Laboratories Pharmaceuticals 25.33 2.58 84,408 11.28 11.31
Limited
Housing
Development
Finance 25.40 2.54 56,393 11.08 23.99
Finance
Corporation Ltd
Tata Computers -
Consultancy Software & 19.08 2.41 122,484 10.51 3.73
Services Ltd. Education
Oil & Gas,
Oil & Natural
Petroleum & 11.77 2.14 114,541 9.34 -5.75
Gas Corpn Ltd
Refinery
Hero Honda Auto & Auto
15.29 1.81 114,317 7.91 98.83
Motors Ltd ancilliaries
ING Vysya Bank
Banks 14.87 1.73 340,635 7.57 -21.63
Ltd
Tobacco & Pan
ITC Ltd 22.95 1.70 396,081 7.44 -32.25
Masala

74
Sector allocation(%)

75
Auto & Auto

2.88
ancilliaries
Banks 6.12
Breweries &
0.19
Distilleries
Cement 1.79
Chemicals 0.79
Computers -
Software & 7.85
Education
Consumer Durables 3.15
Current Assets 6.22
Diversified 1.87
Electricals &
Electrical 1.64
Equipments
Engineering &
2.70
Industrial Machinery
Entertainment 4.56
Fertilizers, Pesticides
1.62
& Agrochemicals
Finance 7.31
Food & Dairy
2.32
Products
Hotels & Resorts 0.30
Housing &
4.92
Construction
Metals 2.54
Mining & Minerals 0.38
Miscellaneous 0.09
Oil & Gas,
Petroleum & 6.74
Refinery
76
Asset allocaton
Cash &
Equity Debt
Equivalent
93.78 0.00 6.22
DSP Merrill
Lynch Tax
Saver Fund -
Growth
CNX500
BSE Sensex

77
CHAPTER 4
RESEARCH ANALYSIS AND

CONCLUSION
78
DSPML World Gold Fund invests in stocks of companies engaged in gold mining &
production. The fund's assets have more than doubled in a span of 4 months, all
thanks to the returns it earns...
DSPML Gold Fund's returns have given investors reasons to cheer.

The previous year gave investors of the DSPML World Gold fund many reasons to
smile. The fund, which listed in September last year, has delivered 42 per cent returns
since its launch. This year (till February 1, 2008), the fund, which is part of the Equity
Specialty category has delivered around 8 per cent returns compared to the category's
11 per cent loss during the same period. The Sensex and Nifty were down 10 per cent
and 13.4 per cent respectively during this period. In the December 2007 quarter, the
fund's returns at 16 per cent were much ahead of the benchmark FTSE loss of 0.15 per
cent. However this is less than the Sensex's gain of 17 per cent in that quarter.
The DSP World Gold fund does not buy gold directly but invests in stocks of
companies engaged in gold mining and production world over. It does so by buying
units of Merrill Lynch International Investment Funds-World Gold Fund (MLIIF-
WGF). In fact MLIIF -WGF forms over 97 per cent of the fund's portfolio. The fund's
good returns can be attributed more to the fact that the gold prices have peaked to a
30-year high, resulting in a bonanza for the companies in this field. A weakening US
dollar and an unprecedented rise in oil prices have also made gold an attractive

79
investment avenue. However, investors looking to invest in gold must not confuse this
fund with gold exchange traded funds (ETFs), which invest directly in gold. Another
difference between DSPML Gold Fund and other ETFs is that the former is managed
actively.
According to the DSPML website, DSPML World Gold Fund has invested over 80 per
cent in gold followed by platinum (9 per cent) and silver (5.10 per cent). As per the
December 2007 portfolio, Australia based Newcrest Mining is the top holding of the
fund accounting for 8.4 per cent of the fund's assets, followed by Barrick Gold (7.50
per cent), Kinross Gold (5.50 per cent) and Lihir Gold (5.20 per cent).
So far, many investors have flocked to this fund. The fund's assets under management,
which stood at Rs 692 crore in September 2007, have more than doubled to over Rs
1487 crore in December 2007.
This fund has done well in its short life, but will DSPML Taxsaver suffer from an
over-diversified portfolio?
Despite the fund manager's explanation, we believe that this fund is unreasonably
spread out. No doubt, DSP Merrill Lynch is known for its extremely diversified
portfolios, but this one is very bloated with 86 stocks (it was 97 in March). Being a
small fund, one should not be surprised that 51 of the stocks have an allocation of less
than 1 per cent and an additional 26 stocks, less than 2 per cent. The top 10 holdings
corner a modest 30.1 per cent of the portfolio.
While this may be interpreted as a lack of conviction which could hinder
performance, one can't really argue with the numbers. While it outperformed the
category average in the first two quarters of its existence, its performance in the
December quarter (2007) was impressive. The fund's success stemmed from its
exposure to surging mid- and small-caps. The size of the fund favoured a mid- and
small-cap tilt and the fund manager capitalised on that wave. The BSE Mid Cap
delivered almost 32 per cent that quarter and BSE Small Cap 46.69 per cent, against
17.33 per cent of the Sensex.
But it was this very exposure that proved to be the chink in the fund's armour. In the
very next quarter, mid- and small-caps were massacred. Naturally, the fund followed
suit. It delivered 47.23 per cent in its best quarter (October 8, 2007 - January 7, 2008)
and delivered its worst immediately after with -37.14 per cent (January 4, 2008 - April

80
4, 2008). Subsequently, the fund's large cap exposure rose from 23.27 per cent in
December to 44 per cent by April.
What the fund manager seeks for this fund is simple: to go about delivering returns in
a consistent manner with no market-cap or sector bias. In some cases, he holds on to
his stocks. In others, he exits the moment he has achieved his price objective and will
probably re-enter at a later date.
So stocks like Yes Bank, Development Credit Bank and Welspun-Gujarat Stahl
Rohren Ltd that made money for him were in his portfolio for 12 months or less. And
while he probably did make money in Educomp Solution and BF Utilities, he would
have made more money had he stayed on for a few more months. But then you can't
really hold it against him since fund management is all about taking a view.
Though the fund was off to a good start with notable quarterly numbers, it is still very
young. However, going by the pedigree of the fund house and the manager at the
helm, this one could turn out to be a strong contender in the tax-saving category.
The data given below consists of daily NAVs of benchmark index S&P CNX 500 for
two months. Opening value. closing, high and low values during the day is given. The
daily returns in percentage form is calculated and tabulated. Also the calculated daily
returns of two DSP ML schemes, who follow this benchmark index is also tabulated.
The analysis is explained below the table:
Date Open High Low Close daily returns in %

S & P CNX500 govt.sec. A tax saver
2-May-08 4290.95 4291.2 4258.6 4280.4
5-May-08 4298.3 4315.95 4260.1 4267.85 -0.29 0.17 0.35
6-May-08 4260 4271.55 4189.9 4217.5 -1.18 0.06 -1.13
7-May-08 4217.9 4227.3 4176.4 4198.6 -0.45 -0.12 0.27
8-May-08 4151.9 4164.55 4137.15 4152.3 -1.10 -0.24 -0.69
9-May-08 4131.2 4161.45 4052.65 4064.1 -2.12 -0.06 -2.26
12-May-
08 4038.95 4074.4 3992.9 4066.3 0.05 -0.04 -0.13
13-May-
08 4101.4 4126.4 4032.25 4041.5 -0.61 0.49 -0.38
14-May-
08 4022.1 4087.5 4022.1 4081.3 0.98 -0.09 0.95
15-May-
08 4103.85 4161.15 4103.85 4159.3 1.91 -0.02 1.85
16-May-
08 4190.9 4204.9 4159.65 4198.1 0.93 -0.2 1.22
20-May- 4170.5 4189.2 4133 4158.9 -0.93 -0.25 -0.51

81
08
21-May-
08 4119.6 4186 4119.6 4174.6 0.38 -0.02 0.84
22-May-
08 4166.55 4166.55 4090.85 4099.85 -1.79 -0.22 -1.13
23-May-
08 4122.9 4134.25 4034.2 4037.35 -1.52 -0.12 -1.50
26-May-
08 3987.45 3998.25 3953.2 3962.5 -1.85 -0.21 -2.07
27-May-
08 4004.55 4007.75 3935.65 3944.2 -0.46 0.1 -0.63
28-May-
08 3959.2 3996.95 3926.5 3991.5 1.20 -0.42 0.91
29-May-
08 4021 4021.5 3917.25 3939.4 -1.31 0.26 -0.74
30-May-
08 3973.25 3992.5 3927.75 3959.65 0.51 -0.13 0.28
2-Jun-08 3987.85 3987.85 3833.8 3853.55 -2.68 0.02 -1.91
3-Jun-08 3810.4 3837.8 3761.65 3831.65 -0.57 0.08 -0.94
4-Jun-08 3837.5 3849.8 3709.1 3719.4 -2.93 -0.1 -2.63
5-Jun-08 3724.75 3782.15 3669.2 3774.6 1.48 -0.07 1.31
6-Jun-08 3816.75 3816.75 3721.8 3730.5 -1.17 -0.03 -0.97
9-Jun-08 3661.7 3661.7 3542.65 3611.8 -3.18 -0.02 -2.69
10-Jun-
08 3588.6 3622.3 3516.85 3570.6 -1.14 0.03 -0.54
11-Jun-08 3587.65 3643.45 3587.65 3632.35 1.73 -0.02 0.92
12-Jun-
08 3533.3 3651.15 3532.1 3645.6 0.36 0.11 0.77
13-Jun-
08 3659.3 3659.3 3616 3634.8 -0.30 -0.19 0.27
16-Jun-
08 3677.8 3716.15 3669.5 3679.75 1.24 -0.26 0.54
17-Jun-
08 3680.85 3761.25 3671.95 3753.55 2.01 0.16 1.46
18-Jun-
08 3770.5 3781.15 3692.55 3701.2 -1.39 0.17 -1.01
19-Jun-
08 3648.45 3668.6 3625.8 3633.45 -1.83 -0.11 -1.66
20-Jun-
08 3644.25 3652.45 3498.75 3510.95 -3.37 -0.33 -3.08
23-Jun-
08 3471.8 3486.45 3393.7 3416.6 -2.69 -0.5 -2.53
24-Jun-
08 3423.15 3446 3337.8 3359.05 -1.68 0.02 -1.62
25-Jun-
08 3306 3406.55 3292.65 3401.05 1.25 0.21 1.40
26-Jun-
08 3429.95 3441.55 3390.4 3431 0.88 -0.3 0.42
27-Jun-
08 3374.2 3374.2 3284.2 3293.65 -4.00 0.01 -2.69
30-Jun-
08 3296.85 3310.5 3191.45 3203.35 -2.74 0.01 -1.77
co-variance 0.024 2.046
std.dev 1.595 0.191 1.364

82
variance 2.543 0.036 1.860

correlation 0.079 0.965
beta 0.009 0.825
The beta value of government sector fund is almost zero. This means the fund
performs as the benchmark, whereas the second fund of taxplan, the beta value is
0.825, which means the fund perform better than the benchmark index.
Results from the modeling are presented in a step-wise manner, starting with
the knowledge construct and ending with the dependent variable (RETURN).
The central construct in this study is knowledge, and the questionnaire included
several different indicators of self-assessed knowledge. The appropriate method to
analyze such data is to regard the multiple measures as fallible indicators of a
theoretical construct, and to test whether the implications of such a model are
empirically justifiable. The presentation of alternative models for relations among the
constructs is done in the following sequence:
1. Alternative relations between knowledge and involvement
2. Alternative relations between knowledge, involvement, risk willingness and
return.
When evaluating an investment (mutual fund in particular), there are many obvious
factors we should consider: returns, risks, expenses, and turn-over ratio, etc. Among
them, the risk factor, when used properly, can help us gauge what we can expect from
the investment, though past performance does not necessarily indicate future results.
There are important systematic relationships between stock returns and economic
variables that may not be captured adequately by a simple Beta measure of risk. Beta
changes over time and its estimation can be “noisy” as a result. Beta is therefore not a
perfect measure of market risk but its relative ease of calculation, availability of
information and link to a theory make it one of the important tools in our tool bag. It
has been soundly critiqued and it’s death announced, perhaps prematurely.
Undoubtedly there will yet be many improvements in the techniques of risk analysis,

83
and quantitative analysis of risk measurement. Future risk measures will likely be
more sophisticated and complex.
The key message for investors is to factor Beta into your investment considerations
and pay as little as possible for the desired Beta (i.e. ETF’s or index funds). Pay
higher MER’s only if you think you have found a manager(s) that can provide future
persistent positive Jenson Alpha -a measure of risk- adjusted return.
Jensen’s Alpha represents the ability of the fund manager to achieve a result that is
above what could be expected given the risk in the fund. If the realized return is larger
than that predicted by the overall portfolio Beta, the manager has added value. Jensen
Alpha=the return of the fund above the risk-free rate less the return of the fund above
the risk free rate that the Beta risk factor predicts=RF-T-bill rate-fl (RF-T-bill rate).
The bigger the Beta the better. If markets were completely efficient, the Alpha value
would always be zero since all available information and analysis would already be
priced into the shares. It would only be possible to achieve a return according to the
risk taken. However, most mutual fund managers claim that this is not the case and
that selecting special under-priced shares can achieve returns in their funds above
what is expected from the risk taken. When looking at Alpha values, it is important to
use a long time frame. To get a realistic view, a minimum of one year is needed, while
three years is preferable.
There probably will never be a ultimate risk measure. In the meantime, Beta is at the
least a useful tool, combined with others, in assessing an investment in a mutual fund
for your portfolio.

84
BIBLIOGRAPHY

85
REFERENCES
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D’Investissement, the European umbrella organisation of the investment fund
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private investors’ evaluation of risk and return 8th August, 2002 Jenny Jordan Klaus
P. Kaas
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Idiosyncratic Risk and Mutual Fund Return , Zakri Bello, Central Connecticut State
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MUTUAL FUND SUBGROUPS* ELMAR BERNHARD KOCH Winthrop
College
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Knowledge, Involvement, and Risk Willingness on Return on Investments in Mutual
Funds and Stocks RITA MARTENSON Marketing Department, University of
Goteborg, Sweden
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January, p. 4.
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87
20. Journal of Accounting – Business & Management 15 (2008) 90-108 Short-Term

Persistence in Mutual Funds Performance: Evidence from India Sanjay Sehgal and
Manoj Jhanwar
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Rational Markets", Forthcoming, Journal of Political Economy.
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Websites
• www.google.com
• www.mahindrafinance.com
• www.bseindia.com
• www.nseindia.com
• www.amfiindia.com
• www.mutualfundsindia.com
• www.valueresearchonline.com
• search.ebscohost.com

88
ANNEXURE
1. Questionnaire


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Mahindra & Mahindra Financial Services Limited

A summer training report on

“the knowledge of Risk Tolerance that an Investor can handle

(05 May 2008 – 05 Juy 2008)

Under the Guidance of

Mr. TARUN KUMAR SINGH Mr. PRASHANT DUTTA GUPTA

Roll no: 27090

NIILM CENTRE FOR MANAGEMENT STUDIES

1) NAME OF THE COMPANY: Mahindra & Mahindra Financial

2) ADDRESS OF THE COMPANY: M-8, 2nd Floor, Old DLF Colony,

3) PHONE NUMBER OF THE COMPANY: 022- 66526000

4) DATE OF INTERNSHIP COMMENCEMENT: 05/05/2008

5) DATE OF INTERNSHIP COMPLETETION: 50/07/2008

6) SIGATURE AND NAME OF THE INDUSTRY GUIDE: -------------------------

7) DESIGNATION OF THE INDUSTRY GUIDE: “Customer Relationship manager”

8) STUDENT’S NAME: Manish Prasad

9) STUDENT’S ROLL NUMBER: 27090

10) STUDENT’S EMAIL ID: pmanish2001@gmail.com

11) STUDENT’S MOBILE/RESIDENCE NUMBERS: 9871936904/03412240836

NIILM- CENTRE FOR MANAGEMENT STUDIES

I wish him good luck and success in his future

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It is a pleasure to acknowledge my mentors, friends and respondents, though it is still

I would like to express my deepest and sincere thanks to my company guide

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Chapter 2 Review of Literature 17

Chapter 4 Research Analysis and Conclusion 79

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ABOUT MUTUAL FUND INDUSTRY

Fig. Mutual Fund Operation Flow Chart

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ORGANISATION OF A MUTUAL FUND

Fig. Organisation of a Mutual Fund

ADVANTAGES OF MUTUAL FUNDS

The advantages of investing in a Mutual Fund are:

TYPES OF MUTUAL FUND SCHEMES

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History of the Indian Mutual Fund Industry

First Phase – 1964-87

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Second Phase – 1987-1993 (Entry of Public Sector Funds)

Third Phase – 1993-2003 (Entry of Private Sector Funds)

The 1993 SEBI (Mutual Fund) Regulations were substituted by a more

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Fourth Phase – since February 2003

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The graph indicates the growth of assets over the years.

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ABOUT MAHINDRA & MAHINDRA FINANCIAL SERVICES

Investment Advisory Services

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Advertising in the Mutual Fund Industry

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decisions in investment markets follow two dominant criteria: perceived investment

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attitude change. Regarding investment products, private investors’ risk-return

The Relevence of Private Investors’ Judgmental Heuristics for Risk- Return

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Mutual Fund Risk & Return

Mutual Fund Risk & Return