Estimating the performance of a fund based on style analysis

Abstract

Mutual Funds have become a very popular means of investing savings. Generally, mutual funds promise very high rate of returns to prospective investors. However, investors must realize that actual returns obtained after deducting management fees turns out to be lower than what is advertised. Management fees are paid for the efforts expended by the Fund Manager in maintaining an active portfolio. The aim of this study is to devise a procedure that can determine whether it is worth it for an investor to invest in a mutual fund and pay the management fees for an actively managed portfolio. This study will analyse a few mutual funds and try to devise a procedure that will answer the question- Can an investor replicate the style of a fund manager by investing in specific stock market indixes (passive portfolio) and achieve a higher actual return without paying management fees. The primary utility of this procedure will be to help investors take wise decision as in which mutual funds to invest in and which mutual fund managers are worth paying money for. The procedure that this study develops will be applicable only to diversified equity funds in India. This restriction is primarily because the alternate passive portfolio that this procedure uses for comparison uses BSE stock market indices. Although this procedure can also be applied for mutual funds investing in bonds, it doesn't make sense to compare a strategy of investing in bonds (mutual funds) and investing in equity (passive strategy).