Journal Review

Pakistan Economic and Social Review

Volume 47, No. 2 (Winter 2009), pp. 199-214

PERFORMANCE EVALUATION IF PASKITANI MUTUAL FUNDS

Talat Afza and Ali Rauf*

INTRODUCTION

            Increasing number of mutual funds in the developed financial markets indicate investor’s preference for this mode of investment (Huhmann, 2005). Over the years mutual fund industry has experienced tremendous growth, whereas, mutual fund is still a recent phenomenon in some of the developing countries. The growth has been robust which in turn has led to the creation of various types of mutual funds.

            Mutual    Funds    were    introduced     in  Pakistan   in   1962,    with   the   public offering of NIT (National Investment Trust). Currently, this is the only open-ended mutual   fund   operating   in   public   sector. The   formation   of   the   ICP  (Investment Corporation of Pakistan) in 1966 offered a series of close-ended mutual funds which was afterwards divided into two lots in June 2000 and was   then   privatized. Management effectiveness has been also evaluated by many studies through examining relationship of fund returns     with    its  selected    attributes. These studies have generally taken attributes like fund size, fund expenses and turnover ratio in order to show their strong influence over open-ended fund returns. Therefore, looking at the potential of the industry and the need of the small investors, it is important to assess the relationship of fund returns with its selected attributes in Pakistan.

LITERATURE REVIEW

A number of researchers have empirically evaluated the relationship of open-ended fund’s performance with its attributes in different time periods for the developed economies  (Soderlind et al., 2000; Korkeamaki and Smythe, 2004). The effect of fund size on its return can be evaluated by measuring the relationship of fund’s net asset with its return. The consistency of management effectiveness has been the focus of interest for many   researchers. The theory of efficient market also suggests that fund managers should not be   able to generate positive fund returns consistently over a period of time. Most of the studies on mutual fund performance conclude that actively managed funds fail to boost returns   sufficiently so as to recover their expenses back. Hence, one of the most evident findings among the previous studies is the negative relationship between fund return and fund expenses.

DATE AND METHODOLGY

The quarterly sample data is collected for all forty-three open-ended mutual funds     listed  on   MUFAP, from the years 1999–2006 with the average number of observations for  each variable being Two hundred and fifty seven.Where, MUFAP is thenofficial website  which gives the direct facility of further web linkages to every mutual fund in Pakistan.

Glenn (2004) has discussed the negative effect of liquidity on open-ended funds as they have to maintain more cash compared to close-ended funds in order to meet the chance of redemption. Therefore, the liquidity is also included as an additional explanatory variable of the estimated model.

Model 1 (Philpot Model)

Return_it  =        α + β₁ (Αssets_it ) + β₂ (Expense_it) + β₃ (Turnover_it)

+ β₇ (12B-1_it) + β₄(Load_it) + β₈ (Return_t-1,i) + ε_it              (1)

Model 2 (Modified Model)

Return_it  =        α + β₁ (Αssets_it ) + β₂ (Expense_it) + β₃ (Turnover_it)

+ β₄(Load_it) + β₅ (Age_it) + β₆ (Liquidity_it)

+ β₇ (12B-1_it) + + β₈ (Return_t-1,i) + ε_it                           (2)        

Where : i, represent the fund; t, represent the timing period

CONCLUSION

            Existing literature has focused on the management effectiveness of Pakistan’s close-ended funds and has concluded the performance of these funds as poor. However, the present study’s primary contribution is in providing conclusive evidence on the important characteristics of open-ended mutual funds.

The 12B-1 fees has a significant positive relationship with the Sharpe ratio in the second model signifying that this has become important due to the addition of other two factors. 12B-1 allows the fund for the payment of distribution fees to selling agents which in   turn helps fund to increase its performance due to growth and possible economies of scale.