A reliable performance measure to differentiate China’s actively managed open-end equity mutual funds

ABSTRACT

We compare different fund performance measures to examine which performance measures can generate risk-adjusted returns between high ranked and low ranked China’s actively managed open-end equity mutual funds. Our results show that only the six-factor (five factors (market, size, b/m, profitability & Investment facotrs) plus a momentum factor) alpha as the performance measure meets the criteria. Separated by the six-factor alpha, better performing funds have a larger asset under management, a better past 6-month cumulative return, a better stock picking ability, and a higher percentage of hybrid funds. Through our sample period from July 2004 to December 2015, the highest ranked quintile funds generate a monthly risk-adjusted return of 0.24% more than the lowest ranked quintile funds and the six-factor alpha reliably selects a better fund portfolio in both bear and bull markets on the basis of both fund return and holding data. Furthermore, our results from fund trading data show that funds with the highest six-factor alpha rank demonstrate a better trading skill in bear markets, suggesting that those better performing funds exhibit their market timing and stock picking abilities when investors need them most.

KEYWORDS:

• Fund performance measure
• risk-adjusted return
• China

JEL CLASSIFICATION:

• G11
• G23

Acknowledgements

All errors are ours. We are grateful to Jun Xiao, Sheng Huang, and seminar participants at Twilight Star Scheme held by International Institute for Financial Studies at Jiangxi University of Finance and Economics, 2016 Greater China Area Finance Conference.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ According to data from CSMAR database, as of December 2015, the average institutional ownership (including mutual funds, QFII, brokers, insurance companies, social security funds, trust companies, financial companies, banks, nonfinancial companies) of 2607 individual A-share stocks is 4.85%.

² Stock funds are required to hold at least 60% net asset value in stocks at any time and hybrid funds do not have this limitation.

³ Gerakos, Linnainmaa, and Morse (2016) suggest that institutional investors’ outperformance comes from right factor exposures (‘smart betas’).

Additional information

Funding

This work was supported by the National Natural Science Foundation of China under the Grant Number 71463018 and Number 71303098.