A mutual fund is a collective investment scheme, which specializes in investing a pool of money collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets. A fund’s portfolio is structured and maintained to match the investment objectives stated in its prospectus.

One of the main advantages of funds is that they give small investors access to professionally managed, diversified portfolios of equities, bonds and other securities, which would be quite difficult to create with a small amount of capital.

1) Income is earned from dividends on stocks and interest on bonds. A fund pays out nearly all of the income it receives over the year to fund owners in the form of a distribution.

2) If the fund sells securities that have increased in price, the fund has a capital gain. Most funds also pass on these gains to investors in a distribution.

3) If fund holdings increase in price but are not sold by the fund manager, the fund’s shares increase in price. You can then sell your mutual fund shares for a profit.

Mutual fund industry in Pakistan:

This sector is grown in Pakistan few years ago & hold around 55.3 % share in total assets of the non banks financial sectors in FY08. Net assets under management grown more than 13 times in a shorter span of time from FY02 to FY08.Average pay out for investor in FY08 was 18 %

Liberalization has helped to facilitate entry of the private sector in the mutual funds industry. Historically, the industry was dominated by public sector funds. However, creation of an enabling legal framework to allow mutual funds to be set up in the private sector and transfer of ICP-managed closed end funds to two private sector investment advisers in FY03 boosted the number and size of funds under the management of the private sector, increased competition and efficiency of the sector and enhanced the quality of fund management. It also provided opportunity to financial institutions, like banks and brokerage firms, to diversify into fund management through subsidiaries and associated companies.

Performance Review of Non-Bank Finance Sector

The public sector open-end mutual fund, NIT, by its sheer size continues to have a significant

Share of 31.0 percent in the net assets of the sector. As of end-June FY07, the mutual funds sector comprised of 66 funds with 47 open-end funds and19 closed-end funds. The number of funds increased to 95 by end-FY08. Open-end funds dominate the sector, as shown in Table 1, due to investors’ preference for ease of exit and the flexibility this investment option offers. By end-FY08, the share of open-end funds in the net assets of the mutual funds sector was 86.0 percent as compared to the share of closed-end funds at 14.0 percent. Closed-end mutual funds are more suitable for long-term investors. In the absence of the continuous sale and redemption of certificates by a closed-end fund, investors can only exit the fund at the given market price of the shares/certificates in the stock market, which is generally at a discount to the NAV per share/certificate. However, lack of redemption pressure has its advantages for the closed-end fund, particularly with respect to the ability to invest in illiquid, but high-potential small and medium-sized companies to earn high returns, optimizing investment of assets by maintaining low liquidity and saving on marketing and distribution costs.Given the usefulness of closed-end funds, necessary mechanisms may be introduced to facilitate investors who wish to exit a closed-end fund in order to address their primary concern about ease of exit. Internationally, buy-back of shares/certificates of a closed-end fund by its fund manager, prompted by trading of shares at a certain discount to the NAV, is widely used to minimize the difference between the market price of shares/certificates on the stock market and their net asset value (NAV), so that the secondary market price is not disadvantageous to investors exiting the closed-end fund.

An encouraging development in the mutual funds sector is the increasing diversity of categories of funds offered for public subscription ,as also evident from the variety of entrants in the sector during FY08. By the close of the year, equity funds constituted almost 41.0 percent of the mutual funds sector; income funds constituted 23.9 percent, money market funds had a share of 16.2 percent, balanced funds 6.5 percent, Islamic funds 7.9 percent, while the rest consisted of miscellaneous types of funds such as tracker funds and fund of funds. While, equity funds have the largest share in the mutual funds sector in terms of the number of funds as well as the net assets under management, however, the large assortment of options for investors is a reflection of the ability of fund managers to meet the investment needs and risk profile of a variety of investors.

Several studies conducted in order to evaluate the mutual fund performances while fund size has their importance in order to evaluate the fund performances.

The empirical results of prior studies that examined the relationship between risk-adjusted mutual fund returns and the costs of research (the expense ratio) and costs of trading (turnover) that are associated with active investment management are conflicting (Ippolito 1993). On the other hand, Sharpe (1966) observed that mutual funds with higher reward-to-volatility ratios tend to be those with lower expenses.

The growth in fund size may cause a manager to boost returns by deviating from the fund’s stated investment objectives. As R.B. Clelland of R.J. Metcalf Associates pointed out (Herring 1996):

Size alone does not hamper money managers; the issue is style. It really boils down to prudent restraints and portfolio diversification. (p. 18)

With increasing size, a fund manager is likely to engage in strategies (e.g. market timing) or invest in assets that would normally not have been chosen because of policy constraints (e.g. a policy limiting change in the value-growth orientation.

Growth in the size of net assets initially provides cost advantages because growth increases net returns. That is, because transaction volume is relatively larger for the larger funds, brokerage commissions on the execution of trades for large firms are lower. In addition, the costs of access to data, research services, and support, as well as administrative and overhead expenses, do not rise in direct proportion to fund size. Daniel C. Indro, 1999 mentioned that effect of fund size on its return can be evaluated by measuring the relationship of fund’s net asset with its return. Prior studies have indicated that smaller the size of fund, the higher is its operating efficiency. Robert (1988) concluded that the smallest quartile of US funds size achieved superior performance in comparison to other quartiles. The conclusion specifically indicated that the smallest quartile had significant positive risk adjusted returns as measured by Jensen Abnormal Performance Index at 90% level of significance. Gorman (1991) also found that small mutual funds, as measured by net assets, perform slightly better than large mutual funds. These results indicate that mutual funds quickly exhaust economies of scale and experience decreased returns (Becker and Vaughan, 2001; Chen et al. 2004). Consistent with these researches, Soderlind et al. (2000) evaluated the relationship between fund performance and fund size in the Swedish market and concluded that better performance is achieved by the equity funds that are smaller in size.

Literature review:

In a study of Daniel C. Indro, they mentioned that Fund size is of vital importance in order to evaluate mutual fund performance .Mutual funds must manage a minimum fund size in view of attaining satisfactory returns to substantiate their costs of obtaining and dealing with information. Moreover, there are diminishing marginal returns which becomes negative when the fund size of mutual fund exceeds. Study sample of 683 equity funds, 1993-95 periods, we evaluate that 20 % of the mutual funds were smaller fund size and 10 percent of the largest funds were over invested. Moreover value and blend fund have more to expand than growth funds from these information behavior. Growth in size of assets increases returns and offer cost advantage, this is because larger funds have more transaction volume.Previous studies related to mutual fund returns for obtaining and trading information were prove to be unsuccessful in identifying the effectiveness of investment strategy relating to fund size. Therefore in order to achieve substantial growth right level of fund size have to be maintained in order to achieve good returns. Study reveals that blend and value funds are more likely to draw higher gains to information activities than do growth funds.

An study was made by (Talat Afza & Rauf) on open ended funds in which performance of mutual funds evaluated through different attributes such as fund size, expense ratio. turnover ratio, age,12B-1 load & liquidity and it showed a significant impact on mutual fund performance which also helped investors while making investment decisions. It is clearly mention that fund size is not helping to increase the return.

As research by (Daniel C. Indro, 1999) in which they studied how fund size affects mutual fund performance? Mutual fund should also maintain an optimal size in order to get the better return which will also justify their information & research cost.

In research of (Titman, 1989) they analyzed the mutual fund performance with their past performance on the basic of few securities attributes such as firm size, dividend yield, past return, skewness, interest rate sensitivity & CAPM beta. And found that past performance is a key attribute for investors before investing in a mutual fund.

A study was conducted on the optimal size of Net assets under management by (Sean Collins & Philip mack 2004) in which they focused on economies of scale in which net assets of mutual fund should be utilized efficiently by spreading the fixed cost & as well as research cost over a large asset base. Three types of funds evaluated with their expenses and their fund size. Fund size under 20 billion to 40 billion could achieve economies of scale while small funds have space for their diversification opportunity while an optimal asset size should be a full service provider in order to get the distinctive competency in industry.

A study also focused (James L .Davis 2001) on the relationship of performance with style of fund manager. Data from 1962 to 1998 was used in this research specifically for equity funds; Fama-French three factor model used in order to interpret the relation of performance with style of fund managers & concluded on the result that no investments style in the above mentioned period generated any abnormal return.

A research by Joseph Chen, 2004 on fund size affects on performance showed by the different attributes such as turnover ratio, expenses, age, flow, fund size. Study strongly showed negative relationship of funds return with fund size. Also explained that return & fund size relationship is also associated with liquidity or price impact. Large funds attract investors through advertisement and marketing activities while small funds rely more on performance to attract & maintain investors. He also mentioned the effect of fund size on performance is very loud which invested in small stocks also suggested that liquidity is a key attribute when size erodes performance of funds.

The study of Servaes, 1999 is based on sample of 1163 mutual funds opening started over the period 1979-1992, this study focuses on fund family behavior of opening new funds when there are more prospective of generating additional fee income. We find that fund openings are positively related to the level asset investment and the capital gains associated with it, there are more possibility of funds opening when size of investment is large, it also depends on past performances of the funds, low fee range and large families decision of opening funds which would develop their fame as brilliant performer by increasing there product line, large families innovate and smaller families imitate.

Further more experience large families who have opened funds in the prior years are more prone to open new funds

In this study of S. P. Kothari and Jerold B. Warner performance of mutual funds are measured, using imitated funds, holding actual fund characteristics. Non market factors are accounted in this study focusing on size of fund, momentum and book-to market. We find that these performance measure have very less aptitude to sense large magnitude for example 3% per year, of the abnormal performance of fund mainly when funds style individuality vary from those of value biased market portfolio, characteristics based methods to evaluate return to return size. momentum and book to market, can display self-effacing enhancement over regression procedures but these power evaluations may be misty the reason being the style-based funds show wrong measurement in both types of measures at times. Study also exhibits that fund’s stock trades can significantly improve power. Though there is large journalism on mutual fund performance measures but the aptitude to sense abnormal performance for an individual fund has established very less notice.

Main communication of this study is that mutual fund performance measures are changeable and undependable can lead to wrong conclusions and abnormal performance are hard to detect when they are present mainly when funds style individuality vary from those of value biased market portfolio.

Karen Ruckman mentioned In his study of Expense Ratios of North American Mutual Funds explains causes that decides Management expense Ratio in North American Mutual Fund market in order to explain the interest which apply on those Canadian funds. It is evaluated that Canadian MER is comparatively higher because of several reasons which include that on average Canadian funds are smaller having less competitor funds. The expense Ratio paid by Canadian shareholders is 50% more than what is paid by US investors because Canadian funds do not take benefits from economies of scale.

With this there are bigger numbers of Index funds in US with lower MER which keep the average MER of US funds towards lesser rate as compared to Canadian one, with this higher clip fee charges of Canadian funds, higher Marketing expenses in Canada and labor charges are some of the other factors as well.

Monopolistic competition use by Mutual fund industry allow different funds to have different characteristics to lay dissimilar expense ratio and this Monopolistic approach has advantage for bookkeeping for these two divergence. But bigger fund volume and size in United States show the way to economies of scale and the benefit of economy of scope is not prevailed by Canada due to smaller fund size and significant difference in the cost factors of the two entities.

According to Mark M. Carhart, 2002 Mutual fund Survivor offer detailed study of fund existence concerns with the help of Carhart (1997) data. Funds live many years depending upon their average multiyear performance, which suggest performance determination leads to mutual fund existence and disappearing of funds from market is the result of their poor multiyear performance. For US 1 year mutual funds the annual partiality increases from .07% as compare to the 1% for funds more than 15 years which shows existence condition or survivor time deteriorates facts of persistent performance this survivorship condition also effects funds characteristics itself and also its performance. not only performance but persistence performance and may lead to fund erosion as many profitable datasets contains only fund which are currently in operations and for funds to be included in study or analysis requires to survive for minimum timeframe.

Goetzmann and Jorion (1999) study of how equity market departure is accustomed upon a downward float in performance over time, also propose that survivor biases are expected to be a difficult for practical studies using international data. And study of Mark M. Carhart, 2002 elaborate the importance of both the nature of the survival and the sample period span at the time of trying to illustrate survivorship biases.

Taking survivor partiality sample Mark M. Carhart expresses Persistence in Mutual Fund Performance and reveals that basic causes in returns and expenses of investments in stock entirely elucidate persistence in equity mutual funds and threat attuned returns.

Hendricks, Patel and Zeckhauser’s (1993) Jegadeesh and Titman (1993),

Study is typically obsessed by the one year momentum outcome but funds individually don’t make higher returns by momentum approach in stocks.

The only important determination not elucidate is strong underperformance by the awful returns in mutual funds. The outcome of which is not even supported by expert portfolio managers. Mutual funds persistent performance is not the sign of good stock picking capabilities but to certain extent it’s explained by common factors such as returns on stock, its expenses, and cost of transaction explains the certainty of returns. Study also reveals that performance of mutual fund is negatively related to factors such as portfolio turnover and load fess and Expense ratios come out to diminish performance a slight more than one-for-one.

The top ten mutual funds earn back their investment overheads, the bottom ten funds conversely underperforms by about double their accounted investment overheads. Christopherson, Ferson, and Glassman (1995) reach parallel outcome about pension fund act.

This article proposes three significant set of laws for maximizing returns. One of which is evading from investing in funds having poor performance another important point is funds with high income previous year have more higher expected returns the following year, but not in years from then on and third is the negative relation of performance with factors like expense ratio, transaction cost and load fees.

Significance of Study:

Nowadays technological advancements, awareness tools are in reach of almost everyone. Mutual fund industry is expanding in Pakistan day by day. We do not have as such research on our mutual fund industry which can play an important role for investors or researcher to get awareness on our mutual fund industry. Mutual fund industry is a like a deep ocean in which so many research could be done which will also help out investor for choosing mutual fund types and will also help out fund managers to change their strategies. There are so many studies conducted on Pakistani mutual fund industry but fixed income/money market fund type is still uncovered in research. Fund size play an important role in the performance of mutual fund, and this study will be based on fund size and their impact on fixed income /money market fund.

This study will also help an individual investor, financial institutions, researchers as well as policy makers to get the idea of fund size and its relation with performance of mutual funds specifically for fixed income & money market fund as their bread and butter is fund size.

Objective of Study

This study will be based on fund size which is an indicator of mutual fund performance measurement for fixed income & money market. Whereas size of fund, cost of transactions and performance are the main elements of evaluating mutual fund performance.

Data collected of fixed income funds as well as Money market fund from 2007 to 2009. From MUFAP as well funds annual report.

Size of funds, Expense ratio and Funds age variables used in this study to evaluate the performance of fixed /money market funds.

The ultimate beneficial owner for this research will be investor as well as researcher who would be able to know that how all market determinants affect on mutual fund return and their performance &Which factor affect most on performance and it will further elaborate that how a fixed income is safer to invest as compare to equity fund at it will also explain that how a fixed income fund is more beneficial for individual investors as well as corporate investors in comparison of BANKS?

Dependent Variable:

Return: Actual return mean profit over investment in a given period. In mutual fund it includes Dividend, capital gains, Interest realized in a year.

Return can be calculated through different ways which is applicable in industry. Talat & Afza uses the regression model of Philpot et al. (1998), which was particularly used for evaluating management effectiveness of US bond mutual funds.

Model 1 (Philpot Model)

Returnit = α + β (Αssetsit) + β2 (Expenseit) + β3 (Turnoverit) + β7 (12B-1it) + β4 (Loadit) +

β8 (Returnt–1, i) + εit

Where

i, represents the fund

t, represents the time period

Korkeamaki and Smythe (2004) also used a similar regression model to explain the returns over time for Finnish mutual funds for the period 1993-2000.

(Daniel C. Indro, 1999) used the 683 non indexed US equity fund annual return available on the database of morning star.

Performance in terms of growth of Net Asset Value (NAV) per unit is commonly applied measure of performance of mutual funds. According to Firth (1977), the growth of NAV is measured in terms of rate of return over a period of evaluation using the following equation:

R1 = D1 + (P1 – P0)

R1 = Rate of Retun P1 = current price

D1 = Dividend for the period P0= Old Price

Independent Variables

Fund Size

(Assets under management): Net assets under management collected from each annual report also confirmed from MUFAP research department.

Using a small sample of funds from 1974 to 1984, (Titman, 1989) find mixed evidence that fund returns decline with fund size. Fund size may be correlated with such other fund characteristics as fund age or expense ratio. Fund size (as measured by the log of total net assets under management

Growth in the size of net assets initially provides cost advantages because growth increases net returns. That is, because transaction volume is relatively larger for the larger funds, brokerage commissions on the execution of trades for large firms are lower. In addition, the costs of access to data, research services, and support, as well as administrative and overhead expenses, do not rise in direct proportion to fund size. (Daniel C. Indro, 1999)

Our proposed hypothesis is mentioned below in which we are assuming a positive relationship between fund size and return.

Fund size has a positive relationship with the return.

Return ∞ Size

Fund Age: As the name shows age mean since when the fund is operating in market. Age will be calculated by the number of years the fund is operational (rauf, 2009)

As age increases it is deemed that efficiency increases therefore, returns are also supposed to increase resulting in a positive relationship.

Age of funds has a positive relationship with return of fund.

Size ∞ Return

Expense Ratio: The expense ratio is the portion of the fund’s assets paid for operating expenses and management fees, including 12b-1 fees, administrative fees, and other asset-based costs incurred by the fund but excluding brokerage costs (Daniel C. Indro, 1999) .Expense ratios are the costs they pay investment managers to become informed. Each fund’s return, expense ratio, turnover, and net assets for each year in the 1993-95 periods are available from Morningstar.

Expense ratio has been measured by mutual fund’s quarterly operating expenses (including management fees, distribution fees, and other expenses) as a percentage of the fund’s average net assets. If by spending more resources on active management, managers increase the return then expenses regression coefficient should be positive (Talat Afza)

Blume, and Crockett (1970) reported an insignificant negative correlation between risk-adjusted mutual fund returns and expense ratios & Elton, Gruber, Das, and Hlavka (1993) found that risk-adjusted returns exhibit a negative correlation with expense ratio.

Expense ratio relationship with return of fund.

Expense ratio ∞ 1/Return

Hypothesis Testing:-

In this study we will check the behavior of return with respect to fund size of fixed income fund.

Fund size has a positive relationship with the return.

Return ∞ Size

Expense ratio relationship with return of fund.

Age of funds relationship with return of fund.

Scope of study:

This research consists of open ended fixed income & money market mutual funds for the period of 3 years (2007 till 2009).

Majority of fixed income/money market funds launched in these 3 years.

After the crisis of stock exchange investor tend to take interest in fixed income/money market funds in which capital amount remains safe.

Limited studies conducted on fixed income fund in Pakistan Mutual fund industry.

Limitations of study:

Fixed income and money market constitutes a major part of mutual fund industry & all these funds launched in last 3 years so we can only study 3 years performance.

Only 14 income funds & 5 money market funds were operational in 2007 in Pakistan mutual fund industry in which companies were very small and we can say non operational like AKD,AMZ,Noman Abid ,Dawood & so on.

In this research we are focusing on 15 funds which are big in size and hold some market share.

Data collection:

Data collection was an integral part of this research .it’s necessary to ensure data validity & reliability. Quality of data can break or change the impact of results. Data are necessary in order to check the impact on dependent variable due to the change in independent variable.

Data collected from different resources which are mentioned below:

Mutual fund association of Pakistan.

Karachi stock exchange of Pakistan.

Asset Management Companies.

State Bank of Pakistan Library.

Interviewed of Mr. Nehal Cassim who is a CEO of Safeway fund as well as MUFAP director.

Interviewed of Mr. Rizwan Habib who is a Finance Manager of JS Investments.

Meeting with Mr. Junaid Qamar who is a fund manager of UBL funds.

There are 15 mutual funds are included in our research in which 10 are income funds and 5 are money market funds. Data collected from 2007 till 2009 as mostly fixed income /money market funds launched in this period. Only 4 income funds were operating in 2005 in Pakistan.

Variables are mentioned below which used in this research.

Fund Size (asset under management): Net assets under management collected from each audited annual report and for the reliability & validity we also ensure the from MUFAP database.

In muual fund industry net assets include bank deposits, certificate of investments, treasury bills & TFC’s, TDR and all income receivables excluding short term liabilities such as NCCPL payments, SECP payments, Banks charges and so on.

Fund Age: as the name shows age mean since when the fund is operating in market. We have seen the impact of age on performance while collecting data. In this research all work done on yearly basis.

Expense Ratio: A measure of what it costs an investment company to operate a mutual fund. An expense ratio is determined through an annual calculation, where a fund’s operating expenses are divided by the total assets under management .all expenses excluding brokerage cost or transaction cost divided by net assets under management. The largest component of operating expenses is the fee paid to a fund’s investment manager/advisor. Other costs include recordkeeping, custodial services, taxes, legal expenses, and accounting and auditing fees. Some funds have a marketing cost referred to as a 12b-1 fee, which would also be included in operating expenses. All expenses & brokerage cost of different funds are available on annual reports.

Return: Actual return mean profit over investment in a given period. In mutual fund it includes Dividend, capital gains, Interest realized in a year.

Statistical Test and Instrument:

The technical tool which we used in this research in order to evaluate the performance of mutual funds is SPSS.

Regression analysis is applied on 3 years Data (2007,2008,2009)

Dependent variable is Annual Return.