Classifying mutual funds in India: some results from clustering

Indian Journal of Economics and Business, June, 2007 by Gajendra Sidana, Debashis Acharya

Abstract

This paper attempts to classify hundred mutual funds employing cluster analysis and using a host of criteria like the I year total return, 2 year annualized return, 3 year annualized return, 5 year annualized return, alpha, beta, R-squared, sharpe's ratio, mean and standard deviation etc. The data is obtained from Valuresearchonline. We do find evidences of inconsistencies between the investment style / objective classification and the return obtained by the fund.

I. INTRODUCTION

India's mutual fund industry has grown dramatically over the last few years. In 2003-04 a sum of Rupees 47873 crore was mobilized by mutual funds. Out of this Rupees 41510 crore was mobilized by private sector mutual funds. One can envisage significant room for growth in the mutual-fund business since a small fraction of the country's savings is invested in the capital markets. Foreign money managers have also started pouring money into the mutual fund market. In this vibrant trading atmosphere, the buyers face the challenge of diversifying their portfolio among different types of funds. The name given to them may not always represent the style management of the fund. The present study makes an exploratory attempt to classify hundred mutual funds employing cluster analysis and using a host of criteria like the 1 year total return, 2 year annualized return, 3 year annualized return, 5 year annualized return, alpha, beta, R-squared, Sharpe's ratio, mean and standard deviation etc, obtained from Valueresearchonline. We do find evidences of inconsistencies between the investment style/objective classification and the return obtained by the fund.

The rest of the paper is organized as the following. Section 2 traces the Indian mutual fund industry in brief. Few past studies have been reviewed in section 3. Section 4 outlines the method and data sources. Results of cluster analysis are presented in section 5 and section 6 offers some concluding remarks.

II. THE INDIAN MUTUAL FUND INDUSTRY

The mutual fund industry in India came into existence in 1963 with the establishment of Unit Trust of India (UTI) *. Its operations began in July 1964 "with a view to encouraging savings and investment and participation in the income, profits and gains accruing to the corporation from the acquisition, holding, management and disposal of securities" (Sankaran, 2003, p.40). UTI had monopoly over the fund industry until the public sector banks and insurance companies entered the industry in 1987. Private sector mutual funds were permitted entry when the Securities and Exchange Board of India (SEBI) formulated comprehensive regulations for the funds. These were replaced by SEBI mutual fund regulations in 1996. Presently the mutual fund industry comprises of the following players other than UTI.

(a) Bank sponsored

(b) Institutions

(c) Private Sector (Indian, Joint ventures-predominantly Indian, Joint venturespredominantly foreign).

Table 2.1 presents the resources mobilized by the above players from 1990-1991 to 2004-2005.

The industry has grown in terms of size, players, and asset management. Mobilizing household savings towards equity capital seems to be inevitable in the emerging Indian market for future economic growth. The role of mutual fund industry assumes significance in this context.

III. SOME PAST STUDIES

Mutual funds ate usually classified on the basis of their objectives. Investors can take the objectives as signals of their risks and incomes if the activities of mutual funds are consistent with their stated objectives.

A study by Copen et al. (1996) investigated the manner in which consumers made investment decisions for mutual funds. Investors reported that they considered many nonperformance related variables. When investors were grouped by similarity of investment decision process, a single small group appeared to be highly knowledgeable about its investments. However, most investors appeared to be naive, having little knowledge of the investment strategies or financial details of their investments.

JIN Xue-jun and YANG Xiao-lan (2003) analyzed mutual fund objective classification in China by statistical methods of distance analysis and discriminant analysis. The authors examined if the stated investment objectives of mutual funds adequately represented their attributes to investors. That is, if mutual funds adhered to their stated objectives, attributes must be heterogeneous between investment objective groups and homogeneous within them. As a whole, they found that there existed no significant differences between different objective groups; and 50% of mutual funds were not consistent with their objective groups.

In the Indian context, Amanulla (2001) tested the portfolio efficiency of mutual funds of Unit Trust of India (UTI) by employing traditional performance measures such as Jensen, Treynor and Sharpe's methodology. Employing Granger Causality and Co-integration tests, the paper also investigated the performance evaluation of mutual funds. Average weekly net asset values of 16 mutual funds of UTI and two stock market price indices i.e. Bombay Stock Exchange (BSE) sensitive index as well as S & P CNX Nifty index for the period June, 1992 to July, 2000 were used in the study. The results from traditional measures provided a mixed evidence of performance evaluation while the evidence from Granger causality suggested the existence of uni-directional causality in BSE sensitive index and bi-directional causality in Nifty index. The market index and mutual funds were also found to be co-integrated, indicating a long-run relationship.