performance evaluation of mutual fund

8/8/2019 performance evaluation of mutual fund

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Shikha Singh

PGDM (Finance)2ndYear

AJAY KUMAR GARG INSTITUTE OF MANAGEMENT,GZB

Performance Evaluation Of Mutual Funds

In


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Agenday About Morningstar

y Objective of the Study

y Research Methodology

y

Morningstar Rating Methodologyy Style consistency Metric

y Correlation Analysis Of Style Consistency

y Findings and Suggestions

y Conclusion


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Research Methodology

y Based on Primary Data: Directly collected by Fund Houses

through online database Morningstar Direct.

yLimitations: The Star rating is done for only one category of Mutual Funds.

The study is done only for those funds for which data was

available.


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About

Type: Public ( NASDAQ: MORN)Industry: Financial Services

Founded : 1984

Headquarter: Chicago, US

India Operations: 16 July 2009

Managing Director: Mr. Aditya Agarwal ( Founder ofMutualfundsindia.com)


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Objective of the Study

y To analyse how star rating is done in Morningstar.

y Detailed analysis of the impact of Style consistency on the performance ofIndian equity funds. The following possible connections between consistencyand performance were explored using correlation analysis: Correlation of Style Consistency (and its components Size-consistency and

Value-Growth-consistency) with Returns (with and without Risk-adjustment)

Breakdown of the correlation between Consistency and Returns (in the sameperiod) by separately studying sets ofconsistent funds and inconsistent funds.

Testing the predictive power of Style consistency by correlating consistency in athree-year period with performance in the following 3-month, 6-month and 1-year periods.

Testing the impact of consistency on the Persistence of performance (with and

without risk-adjustments)y Developing or selecting suitable methods to quantify/estimate the following

properties for funds: Liquidity (for Stocks and Bonds)

Style consistency


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Morningstar Rating Methodology

The peer group for each Fund Rating is its Morningstar Category. Ratings are based on funds Risk Adjusted Returns.


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Morningstar Formulation of Utility

Theoryy Morningstar measures a funds excess returns over and

above the return on the risk free asset.

Accordingly Wealth end of the period = 1/(1+RF)

Geometric Excess Return = [(1+LR)/(1+RF)]-1So, Utility Function=u(1+ER)

Morningstar Risk Adjusted Return=


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Morningstar Ratingy After Calculating Morningstar Risk Adjusted Return (2)

y Rank is assigned and percentile is calculated for Peer group.

= Top10%

= Next 22.5%= Next 35%

= Next 22.5%

= Bottom 10%


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Style Consistency Metric


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Value-Growth ScoreThe scores for a stocks value and growth characteristics determine its horizontal placement.

There are five value factors and five growth factors.Value factors:

y Forward Looking

Price/Projected Earnings 50.0%

y Historical-Based Measures

Price/Book 12.5%

Price/Sales 12.5%

Price/Cash Flow 12.5%

Dividend Yield 12.5%

Growth factors:

y Forward Looking

Long-term Projected Earnings Growth 50.0%y Historical-Based Measures

Book Value Growth 12.5%

Sales Growth 12.5%

Cash Flow Growth 12.5%

Historical Earnings Growth 12.5%


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Style Consistency

Style Consistency is derived directly from the Style Consistency

Metric as follows.

y HIGH: Style Consistency Metric is less than 9

yMEDIUM: Style Consistency Metric is between 9 and 29

y LOW: Style Consistency Metric is greater than 29

y The breakpoints of 9 and 29 are static following a 20-60-20

rule. That is, roughly 60% of portfolios will be labeled as

Medium, and 20% each as Low and High.


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Correlation Analysis of Style

Consistencyy Morningstars Style Consistency Metric is calculated using

deviations in portfolio style over the past three years (the

parameter is calculated every month for a fund).

y

Our analysis shows that there is am

oderately positiveand significant correlation between the Style

consistency observed in a period and the Returns

generated therein. The correlation is even stronger when the

returns are adjusted for risk (0.31 instead of 0.26)

Consistency Consistency


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On the whole, this suggests that there is little predictive power in the Styleconsistency parameter. In other words, knowing the consistency score at a

particular point of time is unlikely to be useful in predicting returns in the next 3, 6

or 12 months.

Dec2009 3Months 6Months 12Months

0.01

-0.11

-0.09

Testing Predicting Power

StyleC

onsistencyRisk Adjusted

Returns


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Testing Persistence

y Hypothesis : highly style consistent funds are more likely to repeattheir performance (whether good or bad). For this, we take our set ofequity funds and order them according to their Style Consistency valuesas of December 2009. Using the ranking order so created, we pick outthe 30% most consistent on the one hand, and the 30% least consistentfunds on the other. Then, for each group, we correlate the Returnsobtained by the funds in the next six-month period (Jan to June 2010),with those obtained in the past 3 years (Jan 2007-Dec 2009).

S.No Data Set Type Risk Adjusted Without Risk

Adjustment

A Consistent 0.51 (Strong) 0.44

B Inconsistent 0.28 0.38

C Overall set(A+B) 0.26 0.24


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y Another fact worth noting :The lowest consistency metric

values (highest consistencies) were around 17.

y In the general classification by Morningstar, a score below 9

is required to be classified as a High consistency fund.

This seems to suggest that equity funds in India are all

rather inconsistent.


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Suggestionsy Morningstar should provide the information regarding Liquidity,

style consistency and other portfolio based parameters such asconcentration risk,Credit quality of portfolio, Average maturityetc.

y

Morningstar should not assign a fixed percentage to liquidity, itdepends what weightage investors want to assign to liquidityparameter.

y Morningstar should also look into style consistency metric.Because throughout the analysis, the lowest consistency metric

values (highest consistencies) were around 17. In the generalclassification by Morningstar, a score below 9 is required to beclassified as a High consistency fund. This seems to suggest thatequity funds in India are all rather inconsistent.


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Conclusion


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Thank You

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