Market timing and stock selection ability of mutual funds in India: An empirical investigation

Abstract

Evaluation of performance of mutual funds and identification of successful fund managers are of great interest to both investors and academicians. Two possible methods that are presumed to be used by fund managers for generating superior performance are identified as: ‣ Market timing: Market timing skills imply assessing correctly the direction of the market, whether bull or bear, and positioning their portfolios accordingly. ‣ Stock selection: Stock selection skills involve micro forecasting, which generally forecasts price movements of individual stocks relative to stocks and identification of individual stocks that are under- or over-valued relative to equities in general. The two pioneering works in this field is by Treynor Mazuy (1966) and Henriksson Merton (1981). They developed two different models for testing the market timing and stock selection abilities of the fund managers but found little evidence of timing by the fund managers in their samples. Most of the other works mentioned in the paper have used these two models (which we name as traditional/unconditional models) or slight variations of the same for testing market timing and stock selection abilities of the fund managers. Person and Scadt (1996) modified the classical performance measures (of timing and stock selection ability) to take account of well-known information variables like interest rate, market dividend yield, etc. They termed it as 'conditional approach' of measuring mutual fund performance and claimed that conditioning on public information controls for biases in traditional market timing and stock selection models. Traditional models have taken the view that'any information' correlated with the future market returns is superior information; in other words, they are unconditional models. Person and Scadt's approach used basically the same simplifying assumptions as the traditional models but they assumed, in addition, semi-strong form of market efficiency. The idea was to distinguish between market timing based on public information from market timing information that is superior to the lagged publicly available information variables. Although the academic literature on stock selection and market timing ability of mutual fund managers is rich and spans several decades, not many studies exist on this issue using emerging market data. This paper attempts to find the stock selection and market timing abilities of the Indian mutual fund managers using unconditional as well as conditional approaches. With a sample of 96 Indian mutual fund schemes, a lack of market timing ability and presence of stock selection ability were observed among the Indian funds managers in both unconditional as well as conditional approaches. A pooled regression was carried out for various categories of funds as well as for the entire sample, which also showed a lack of market timing abilities and presence of stock selection abilities.