A Study of the Performance of Actively-Managed Funds in Asia-Pacific Market

A Study of the Performance of Actively-Managed Funds in Asia-Pacific Market

1. Introduction

According to different allocation strategies of underlying portfolio, mutual funds and Exchange Traded Funds (ETF) (collectively, “funds”) can be classified into two categories, the actively managed fund and the passively managed fund. Fund managers of actively managed funds would construct a portfolio, and conduct transactions more frequently, in order to gain abnormal profits and beat a selected benchmark. On the contrary, passively managed funds usually track an index. Since the managers of actively managed funds usually attempt to outperform market index portfolios, they would charge higher fees, which are probably over ten percent higher than passively managed funds, to compensate high transaction costs.  

As a matter of fact, actively managed funds constitute a major proportion of mutual funds. Despite of the high management fee, some investors choose actively managed funds over index funds because they believe that professional skills of fund managers could bring them abnormal return. However, someone argues that index funds could continuously outperform actively managed funds in an efficient market.

This research aims to analyze the performance of actively managed funds under different circumstances and to provide a guideline to general investors. Multiple factors that concern investors under the current global economic environment will be taken into consideration. First, the rise of the emerging markets has attracted growing attention and investment activities have extended to broader geographic areas. Also, as financial markets and institutions become more sophisticated, both large- and small-sized companies are able to participate in the market activities. Meanwhile, investors have gained better understanding of the complexity of the financial market, and even become more conservative after the 2008 financial crisis.

The objective of the research is to evaluate the performance of actively managed funds under different market conditions, economic status and market sectors. To reduce data noises and simplify research procedure, major focus will concentrate on the performance evaluation of actively managed funds, based on the assumption that the comparable index funds could perfectly track the market indices. Various risk factors will be included in the evaluation models in order to better analyze the performance of actively managed funds. Based on the analysis, we will provide recommendations to investors regarding whether to invest in actively managed funds or simply track the market index through passively managed under different scenarios.

2. Literature Review

Mutual funds are either actively managed or tracking an index. Market observations show that actively managed funds take up a dominant proportion of investors’ portfolios. Nevertheless, historical evidence implies that index funds have repeatedly outperformed active-managed funds during the past few decades, mainly in the developed markets.

Actively managed funds attempt to generate higher investment return than a certain benchmark or a specific market sector by exploiting the market inefficiencies. Active portfolio managers have formulated a variety of strategies, based on both macroeconomic and firm-specific factors. As a result, actively managed funds have enjoyed a tremendous popularity among investors, attracting over 80% of the total investments (Martin, 1993).

On the other hand, empirical analysis done by previous researchers shows that investors holding index funds would achieve higher return than holding comparable active funds. Indeed, the probability of outperformance for index fund starts at 80% level and increases with holding periods. A broader portfolio holding multiple low-cost index funds nudges the probability up to 90% (Soe, 2012).

To explain the reason why index funds have consistently achieved better return than active funds, there are several hypotheses claimed by previous studies.

First, studies followed the zero-sum theory in an efficient market. This theory is based on the assumption that for every dollar outperforming the market, there has to be another that underperforms (Barber & Odean, 1999). Therefore, overall, the active funds are expected to call even with their benchmark. Furthermore, when trading costs are counted in, active funds have much less chance to outperform the market. Market inefficiency in some countries may also be due to high transaction costs (Khababa, 1998).

Alternatively, studies have given credits to the extension of holding periods. It has been noted that index funds have attained a better investment return when the holding period was extended from 5 to 10 years (Ferri & Benke, 2013). This can be explained in that investors are probably not able to pick up the winning stocks consecutively throughout their management periods.

Despite the large database and reasonable methodologies of the past researches, there are some limitations that we have noted in the process. First, past studies appear to focus on developed markets while little attention has been given to emerging markets. The actively managed funds may underperform in relatively efficient market conditions, such as in the developed markets. However, skillful fund managers could achieve abnormal return in less efficient markets, leading to the outperformance compared with the general market. Second, past researches have focused mainly on the return differences between actively managed and index funds whereas some risk-adjusted factors, if counted in, may help to better calibrate the investment skills and performance of the fund managers.

This study aims to evaluate the performance of actively managed funds from a more comprehensive approach, by adding market timing and risk-adjusted factors into consideration. For measurement of market timing, Treynor and Mazuy (1966) proposed estimating by adding a squared term into the linear regression model. For measurement of risk-adjusted factors, a multifactor model introduced by Fama and French (1993) would be adopted to better pinpoint the risk premiums of the market and thus define the level of management skill.

3. Methodology

3.1 Scenario Analysis

We conducted scenario analysis to compare the performance of actively managed fund with market index. In each situation, actively managed equity funds with similar holding period were selected, and the financial performances were compared with a preselected benchmark index fund. The actively managed funds were ranked by the level of management fee, and the time span investigated was 5 years. The actively managed funds should exist in the market within 5 years, in order to avoid the survivorship bias. The objective was to see whether the actively managed funds could beat the market in each situation, and to what degree the fund management skills contributes to the total return.