This paper studies about persistence in mutual fund performance in India,
from 2001-04. It uses several tests from the literature to conclude that there
is persistence in the mutual fund market. It is found that performance
measures that are constructed using large lags of data are better predictors
of future performance. In addition, the predictions of performance for longer
future periods are superior to predictions made for short-run future periods.
Finally, it is found that auto-regression tests for persistence may fail despite
the presence of persistence.
Open-ended mutual funds in India have grown to become very popular, yet highly
controversial investment vehicles over the past decade. While the private sector equity funds
represents the fastest growing financial intermediary in the Indian market over the past few
years, we find that on average, these funds strongly underperform the market1.
An important question emerges—why do investors buy these actively managed mutual
funds despite their relatively poor performance? One answer to this puzzle is that some funds
consistently perform better than the others, and a sophisticated group of investors recognize
this, and therefore invest in mutual funds2. In this paper, we analyze persistence in
performance using a variety of measures, and conclude that it is in fact possible to predict
performance from the past returns.
The importance of a study on persistence lies in its implications for financial market
efficiency. Testing for persistence in fund returns is equivalent to asking a critical
question—is it possible to make correct predictions about future prices using information
available today?
A vast literature3 has emerged in the past 15 years about the presence of persistence in
various international markets. Most of the studies find evidence of persistence, and thenattempt to explain the reason for this through a variety of ways. Examples of extensive
evidence of short-run persistence in the mutual fund returns is found in Grinblatt et al., (1992),
Hendricks et al., (1993), Malkiel (1995), Brown et al., (1995), Gruber (1996), Zheng (1999)
etc. Carhart (1997) records evidence that the persistence is mostly explained by the
underperformers.
In this paper, we apply a range of tests to the Indian mutual fund market in order to analyze
persistence. The choice of tests is determined to a large extent by both data availability, and
the historical background of the Indian fund markets. We now provide a brief description of
the institutional features of the Indian markets. |
