Research On The Investment Selection Ability Of Fund Manager And Fund Shareholder

Contract mutual fund (hereinafter referred as fund) is a system arrangements that fund shareholder entrusts fund management company with money to make a profit from the portfolio set up by fund managers, which are appointed by the fund management company, by means of buying and selling stocks and bonds.The fist open-end mutual fund was founded in September,2001. Because of the advantages of this kind of mutual fund, such as high liquidity, flexible exchange ways, the number of open-end mutual funds increases quickly and open-end mutual funds take up the dominate position in mutual fund market. In April2004, the mutual fund act and other rules were formally implemented. Subsequently, the size of the mutual fund market in china is become larger and larger. In the end of2010, the number of the mutual funds managed by the fund management company reached669, and the total net assets of open-end mutual fund reached2,437,096million Yuan. It will be seen from these data that mutual funds has been become the important investment tools.Contract mutual fund has the follow characteristics in terms of operating process and the relationship between the fund shareholder and fund management company. First, fund shareholder can buy or sell fund-share conveniently at any time, and so sets up or ends ties with the fund management company. Fund shareholder possesses the ownership of the fund assets and fund manager manages the fund portfolio, and fund trustee is entrusted with fund assets for safekeeping and undertakes supervision responsibility. Second, fund management company appoints fund manager to manage the fund portfolio in order to increase the value of the portfolio. Fund management company profits from the management fees charged on fund shareholder on the basis of the size of the fund net assets, hence the size of the fund net assets decides the size the of profit of the fund management company. Thirdly, the return of the fund shareholder originates the gains of portfolio. The gains of portfolio depend on the management ability, namely the security selection ability and timing ability and other abilities. On the other hand, the fund selection ability of the fund shareholder decides the it’s own return.One natural question may be proposed that whether fund shareholder has fund selection ability and timing ability, and another question may also be proposed that whether fund manager has selection ability. Fund manager shows his selection ability into two aspects. One is the security selection ability and timing ability. Security selection ability means ability to obtain higher return by means of identifying the undervalued securities. Timing ability means ability to obtain higher return by means of changing the assets allocation of the fund portfolio or the beta of the portfolio. The second is the industry selection ability. Industry selection ability means ability to obtain higher return by means of investing on the industry with higher return and withdrawing from the industry with lower return.Thus it can be seen that fund shareholder and fund managers are the most important participants and stakeholders in fund market. It is highly significant to study the selection ability of fund shareholder and fund managers.This paper studies the selection ability of fund shareholder and fund managers, and thus includes four aspects. One is the fund selection ability of fund shareholder, and the second is the timing ability of fund shareholder, and the third is the security selection ability and timing ability of the fund manager and the fourth is industry selection ability of fund manager.The first part of this paper is an introduction which depicts the present situation of fund market in China, and describes the research path and framework, and points out the drawbacks of this paper. The second part of this paper is literature review.The third part of this paper presents the research methods applied in the study of the investor’s selection ability and compares these methods. First, the author details the various kinds of methods used in the researches on the security selection ability and timing ability of fund manager. Second, the author also narrates the research methods on the industry selection ability of fund manager. In the last passage of the third part, the author depicts the methods used in the studies on the fund selection ability and timing ability of fund shareholder. On the basis of these depictions, the author compares the research methods in the related research area. The fourth part in this paper studies the security selection ability and timing ability of fund manager in China in the spirit of the TM model and HM model and the methods used in Jiang(2007). The results show that some fund managers indeed have selection ability and timing ability and fund managers show stronger security selection ability than their timing ability. Moreover, fund managers’ security selection ability in bull market is stronger than that in bear market, so the author finds that fund managers have more difficulties in selecting undervalued security in bear market. In addition, most fund managers’security selection ability and timing ability do not show persistence, in other words, most fund manager which show security selection ability and timing ability in bull market can’t show security selection ability and timing ability in bear market.The fifth part of this paper gives empirical evidence about the industry selection ability of fund manager by means of applying two different methods. The follow are the empirical results. First, the return of the fund with high industry concentration is10.77%annually, and the return of the fund with low industry concentration is13.59%annually. So funds with higher industry concentration underperform funds with lower industry concentration by2.8%annually. It can’t bring about better performance that fund managers intentionally allocate the fund portfolio to deviate the market portfolio. Moreover, the panel regression shows that portfolio industry concentration is negatively correlated to the fund performance. Thus fund managers have no industry selection ability. Moreover, the analysis by applying the GT measure proposed by Grinblatt and Titman(1993) to individual fund do not support that managers have industry selection ability.The sixth part of this paper analyzes the fund shareholder’s fund selection ability by applying the methods consistent with that used by Gruber(1996) and Zheng(1999). The empirical results show that open-end mutual investors in China chase the funds with better performance and smaller size. The excess return of the funds bought by investors which is17.06%annually is lower than the excess return of funds sold by investors which is18.56%annually. Funds bought by investors underperform the funds sold by investors. The empirical results also show that funds with higher net cash inflow underperform the funds with lower net cash inflow by2.5%annually. Mutual fund investors in China have no fund selection ability. Moreover, the empirical results show that the dollar weighted return of open-end fund investor in China, which is0.39%monthly, is lower than the fund portfolio average return which is2.4%monthly during the period of January2004through June2008. The performance gap is2%monthly, or24%annually, so open-end fund investor has no timing ability. The empirical results also show that fund performance, along with fund size and fund age, has no significant effect on investor timing ability. Fund net cash flow and volatility of fund return are negatively correlated with investor timing ability and fund expense ratio has positive effect on investor timing ability.The seventh part of this paper depicts the empirical results about the investor behaviors in behavioral finance, and gives preliminary explanations about the selection ability of fund manager and fund shareholder.The first main contribution of this paper is that the author improves the estimation processes of TM model and HM model and increases the accuracy of evaluating the security selection ability and time ability of fund manager. TM model and HM model are, up to now, the fundamental methods studying the security selection ability and timing ability of fund manager. However, estimating TM model and HM model directly and evaluating security selection ability and timing ability of fund manager may cause bias. The author uses the experience of Jiang(2007) and improves the estimation processes of TM model and HM model. The improved methods depicts as follows. First, the daily risk exposure (β) of fund portfolio is estimated by using fund daily return. Second, fund manager’ time ability can be evaluated by estimating the relationship between the daily risk exposure (β) of fund portfolio and the market return. Third, the return due to the security selection ability can be calculated by deducted the return due to time ability from the fund daily return. Fourth, security selection ability can be presented by analyzing the return only due to the security selection ability. Moreover, the author applies the bootstrap method into the estimation process of TM model and HM model and improves the robustness of empirical results.The second contribution is that the author develops the methods used in Kacperczyk et al.(2005) and analyzes the industry selection ability of fund manager individually by applying the GT measure which is proposed by Grinblatt et al.(1993). Kacperczyk et al.(2005) study the industry selection ability of fund manager based on industry concentration of the fund assets portfolio. However, fund assets portfolio includes stock assets and other assets and can’t clearly inflect the industry selection behavior. This paper computes the industry concentration of stock assets based on the industry allocation ratio of the stock assets of fund portfolio. Because of excluding the influences of the ratio of stock assets to the whole assets, the industry concentration of stock assets can reflect the industry selection behavior more accurate than the industry concentration of fund portfolio. This paper studies the industry selection ability of fund manager based on industry concentration of the stock assets and overcomes the drawbacks of Kacperczyk et al.(2005). Moreover, this paper applies the GT measure proposed by Grinblatt et al.(1993)into studying the industry selection ability of fund manager individually and further judges the industry selection ability of fund manager. So this paper expands the research about the industry selection ability of fund manager.The Third contribution is that the author constructs fund portfolio in terms of fund net cash inflow and analyzes the fund selection ability of all fund shareholders as a whole. According to literature retrieval, no researches have been done at present in China.The final contribution is that the author improves and perfects the methods used in Friesen et al.(2007) and analyzes the timing ability of fund shareholder, so the results in this paper become more robust. Friesen et al.(2007) pioneered the new method which analyzes the timing ability of fund shareholder. Friesen et al.(2007) suggested that the timing ability of fund shareholder can be judged by comparing the dollar weighted return with portfolio average return. But there are two drawbacks in the research of Friesen et al.(2007), and this paper overcomes these two drawbacks. First, the author not only computes the dollar weighted return on the basis of real fund assets at beginning of period, but also computes the dollar weighted return supposing real fund assets equals0at beginning of period, so this paper excludes the influences of size differences between funds and increases the robustness of results. Second, this paper sets the range of the solution when computing dollar weighted return by resolving the nonlinear equation of higher degree and reduces the situation which the equation has multi-solution or has no solution, as a result, reduces the sampling bias.