Regime-Switching Determinants of Mutual Fund Performance in South Africa

Richard Apau,Peter Moores-Pitt,Paul-Francois Muzindutsi

doi:10.3390/economies9040161

Abstract

This study assesses the effect of fund-level and systemic factors on the performance of mutual funds in the context of changing market conditions. A Markov regime-switching model is used to analyze the performance of 33 South African equity mutual funds from 2006 to 2019. From the results, fund flow and fund size exert more predictive influences on performance in the bearish state of the market than in the bullish state. Fund age, fund risk, and market risk were found to be the most significant factors driving the performance of active portfolios under time-varying conditions of the market. These variables exert more influence on fund performance under bearish conditions than under bullish conditions, emphasizing the flight-to-liquidity assets phenomenon and risk-aversion behavior of fund contributors during unstable conditions of the market. Consequently, fund managers need to maintain adequate asset bases while implementing policies that minimize dispersions in fund returns to engender persistence in performance. This study provides novel perspectives on how the determinants of fund performance change with market conditions as portrayed by the adaptive market hypothesis (AMH).

Highlights

IntroductionThe investment focus of passive fund managers differs from active managers in terms of strategy and target clientele base
The Markov switching model was employed as a suitable analytical tool to test the effect of fund performance determinants across bullish and bearish conditions of the market
The predictive power of fund flow over performance is more pronounced in the bearish state of the market than in the bullish state, which is indicative of high investor sensitivity to fund performance in lower periods of the market than in upper periods

Summary

Introduction

The investment focus of passive fund managers differs from active managers in terms of strategy and target clientele base. Drivers of fund performance could change with different market conditions, as suggested by proponents of the adaptive markets hypothesis (AMH) (Lo 2012; Al-Khazali and Mirzaei 2017). Explanations posited under the AMH suggest that the stability and efficiency of the financial markets in reflecting realistic values of financial assets is subject to change over time, and that investors and systemic fundamentals would adapt to prevailing conditions over the course of time (Lo 2012; Urquhart and McGroarty 2014). The validation of AMH in the South African financial markets (Obalade and Paul-Francois 2018a, 2018b) suggests that the determinants of fund performance are subject to market conditions

Objectives

Methods

Results

Conclusion