Abstract
PurposeMutual funds are the second most preferred investment option in India and have garnered considerable research interest. The focus of Indian studies thus far has been restricted to the bottom-up approach of investing which rewards a fund manager for picking winner stocks and generates superior returns. While changing portfolio allocation as per varying macro-trends has been instrumental in generating superior returns, it has not been given the desired attention. This study addresses this important research gap.Design/methodology/approachThe authors analyze the industry selection ability of the fund manager on a robust sample by decomposing alpha into alpha due to industry selection and alpha attributable to stock selection. Alpha estimates are computed on a robust sample of 34 open-ended Indian equity mutual funds for a 10-year duration 2011–2020 using three base models of asset pricing – single-factor, four-factor and five-factor alpha under panel data methodology.FindingsThe study leads us to four major findings. One, industry selection explains more than two-fifth of the alpha both in cross-section and time series of returns; two, industry selection exhibits persistence for more than four quarters across asset pricing model; third, younger funds have level playing when alpha from picking right industries is concerned; four, broad industry allocation continues to explain superior returns as sector allocation undergoes consolidation during ongoing COVID-19 pandemic and funds increase exposure to defensive stocks, consistent with folio allocations as per macroeconomic conditions.Research limitations/implicationsThe authors find strong evidence of persistence in the case of alpha attributable to the industry selection component, and the findings are consistent with the persistence results reported in the empirical literature. While some funds excel in stock-picking skills and others excel in picking the right industries, both skills together make for winner funds that attract larger investor flows as investors chase superior performance. The authors also find no evidence of diseconomies of scale in the case of industry allocation alpha generated by the fund managers.Practical implicationsThe results suggest a fresh approach for investors while making mutual fund investment decisions; the investors can achieve superior returns by assessing industry selection skills as it tends to provide a more holistic picture concerning a perennial question – why some funds outperform and continue to contribute to investor's wealth?Social implicationsMutual funds have become a favored investment option for Indian investors more so as a disciplined investment option owing to dismal financial literacy rates. The study throws light on a relatively unaddressed dimension of choosing winner funds. The significance of right sector allocation assumed even more significance with the onset of the pandemic which lends further credence to the findings of the study.Originality/valueResearch has been conducted on secondary data extracted from a well-cited database for Indian mutual funds. Empirical analysis and conclusion drawn are based on authentic statistical analysis and adds to the existing literature.
Highlights
Over the last decade, the mutual fund business in India has grown at a breakneck pace
The results suggest a fresh approach for investors while making mutual fund investment decisions; the investors can achieve superior returns by assessing industry selection skills as it tends to provide a more holistic picture concerning a perennial question – why some funds outperform and continue to contribute to investor’s wealth? Social implications – Mutual funds have become a favored investment option for Indian investors more so as a disciplined investment option owing to dismal financial literacy rates
3.3.1 What constitutes fund alpha or superior performance? As we proceed with the article, we evaluate monthly fund returns following Busse and Tong (2012), utilizing three wellknown asset pricing models – single-factor model ( known as Capital Asset Pricing Model (CAPM)), which utilizes the excess of market returns factor; Carhart four-factor model, which incorporates size, value and momentum factors in addition to the market factor (Carhart, 1997) and a five-factor model, which incorporates an additional factor of Industry Momentum (Moskowitz and Grinblatt, 1999)
Summary
The mutual fund business in India has grown at a breakneck pace. The majority of mutual fund research has examined the role of size, value and momentum aspects in performance indicators linked to empirical asset pricing studies (both at the company and industry level). Recent studies include those by Kacperczyk et al (2005) and Avramov and Wermers (2006). Given the variations in market structure, data availability and fund size, the measure of alpha decomposition has been modified to include a proxy for industry returns rather than the value weights generated by previous studies. This results in a total observation set of more than a lakh observations (149,000 datasets approx.)
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have