Mutual fund or better known as unit trust fund in Malaysia is an investment scheme the pools money from many investors who share the same financial objectives, investment strategy and risk tolerance. The pooled money will then invested in a diversified portfolio of authorized investments by a professionally managed organization on behalf of the unit trust’s investors. An independent trustee is appointed to oversee the management of unitholders’ money. Thus, the rights and interest of investors in unit trust are safeguarded. The unit trusts are also called ‘open-ends’ funds as the unitholders can redeem or sell back their shares through the fund management company at the prevailing buying price or current market values. Unit trust fund is an affordable avenue for investors to achieve a reasonable level of diversification. With the introduction of sector funds in Malaysia since 1959, investors are offered an alternative in making investment decisions.

Besides that, unit trust also plays a very important role in Malaysia capital market. They are among the major players in the market and believed to have the influencing power to attract small investors to capital market (Leong, 1997). It is more appealing and provides a wider investment base for small investors. Consequently, this has created intense competition among the unit trust fund management companies in the unit trust industries. As such, more innovative unit trust products have been developed and introduced in order to attract potential investors.

BACKGROUND OF THE STUDY

Based on the Guidelines on Unit Trust Funds issued by the Securities Commission in October 1991, a unit trust fund company can only invest in authorized Malaysia assets, which include listed and unlisted securities of Malaysian companies, Malaysian Government Securities, Cagamas bonds, bankers’ acceptances, Negotiable Certificates of Deposits, Government Investment Investment Certificates and cash (Banker’s Journal Malaysia, 1995). However, in March 1994, the Commission has provided a provision by which trust funds can invest (10% of portfolio) in overseas stock. Hence, conventional unit trust funds can invest in any of the above Malaysian assets without any restriction as long as the funds have not reached its maximum approved size.

Islamic unit trust fund is one of the Islamic financial products present in the market. These funds are operating in compliance with Shariah (Islamic law) principles. The Shariah’s prohibition against riba (interest) and some Fiqhi (Islamic Jurisprudence) issues in the interpretation of gharar (excessive risk) suggests that many of the instrument products, which are available to conventional funds are not available to Islamic funds. However, in the case of Islamic investment instruments for example, Islamic unit trust funds, fund managers do have some limitations in selecting stocks to form part of their portfolio. Even though most of the banks listed in Bursa Malaysia have Islamic banking arms, due to the Shariah guidelines, fund managers are unable to include banking stocks in their portfolio. Furthermore, due to the absence of Islamic money market, Islamic unit trust funds depend solely on the equity market for investment. For conventional equity unit trust funds, fund managers do not invest solely in the equity market. From an Islamic perspective, the products are avoided as they represent elements that are forbidden by Allah and the harmful effects of such products on mankind (Smart Investor, 2002).

This paper intends to observe the differences in terms of performance between Islamic and conventional mutual fund in the context of Malaysian capital market. There are many type of unit trust such as equity funds, balanced funds, fixed income funds, money market funds and others. However, this study utilises equity fund only because there are considered to be more risky funds as compared to other fund types, but they also provide higher returns than other funds. Equity unit trust funds also are popular in Malaysia as they provide investors with exposure to the companies listed on Bursa Malaysia. The performance of the units is therefore linked to the performance of Bursa Malaysia. A rising market will normally give rise to an increase in the value of the unit and vice versa. The performance of Islamic and conventional unit trusts will be analyzed using monthly data from 2006 to 2011 and evaluated based on the standard performance measures known as Adjusted Sharpe’s, Treynor’s and Adjusted Jensen’s indices.

PROBLEM STATEMENT

Many researchers have been study about the unit trust in the past. Some previous studies found results that are inconsistent with Chua’s findings. These studies get same results with Ewe (1994), Shamsher and Annuar (1995) and Tan (1995). According to Shamsher and Annuar (1995), they found out that the returns on investment in unit trust were well below the risk free and market returns. Their study evaluated 54 unit trusts for the period of late 80s to early 90s. Furthermore, the results indicated that not only the degree of portfolios diversification was below expectation but the actual returns and risk characteristics of funds were also inconsistent with their stated objectives. The study by Tan (1995) analyzed performance of 12 unit trusts over a 10 year period during 1984 — 1993. He concluded that unit trusts in general perform worse than the market portfolio. Consistent with Chua’s findings, Tan also concluded that government sponsored funds performed better than private funds.

Therefore, this research is to evaluate whether the Islamic or conventional equity unit trust funds are better in terms of risk, return and diversification for the five periods from 2006 to 2011. The study analyzed over 60 months period commencing. It also found that the performance of the funds was influenced by the economic condition before, during and after crisis.

OBJECTIVES OF STUDY

This study focused to attempts to investigate the comparative of performance between Islamic and conventional equity funds. The objectives of the study are :-

To compare the nature and characteristics of Islamic and conventional unit trust in Malaysia.

To assess the risk and return profiles of Islamic unit trust in comparison with the conventional unit trust.

To measure the degree of diversification of Islamic unit trust as compared to the conventional unit.

To compare the consistency of performance of equity funds.

SIGNIFICANCE OF STUDY

There are several benefits that can be taken in this study. The information gathered could benefit a few parties and the researcher as well.

Investor

This study will help the investors especially Muslim investor to invest in Islamic unit trust. It also creates knowledge on how far Islamic and conventional unit trust funds perform better. The research also helps the investors to invest and forecast their investment strategy in futures.

Fund Manager

This research will help the Fund Manager get the knowledge and information about the unit trust. It could provide a benchmark to the fund manager of their abilities in selecting and diversification of the fund.

Researcher

This research also helps to enhances researcher’s knowledge and ability to evaluate details on performance of unit trusts funds. From the information, more extensive studies could be planned for the future.

Businesses

This research is very important to businesses in realizing the effects of portfolio management on their performance. This is important so that they will have clear direction in deciding their investment.

SCOPE OF THE STUDY

This study will focus on determine the measure of average daily return, total risk (standard deviation), coefficient of variation,

The data will take from conventional and Islamic equity mutual fund companies available in Malaysia.

The research use the return on equity mutual fund as the dependent variable whereas the return on stock market index (KLCI) as the independent variable for conventional and Islamic fund.

This study will examine by using

LIMITATION OF STUDY

Every researcher has their own limitation or barriers to find the result or outcome. However, in this research it will not affect the overall purpose of the study. The data accuracy had been supported from secondary data. Here are the limitations of the study :-

Since the data used in this research are mainly from various secondary sources, its accuracy and reliability heavily depends on the accuracy of the published materials.

The information about the topic studied is also difficult to search in the library because of the limited information.

Since this research is the first research experience for the researcher, undoubtedly there are still lots of things to improve.

The researcher is still lack of experience in doing research comprehensively but researcher is trying hard to make this project paper successful and committed to complete it properly

The time given is very limited for the researcher to collect all the data and to finish this project paper.

The researcher has limited knowledge on the topic and needs more understanding on the topic studied.

DEFINITION OF TERMS

Equity funds

An equity unit trust is the most common type of unit trust. The major portions of its assets are generally held in equities or securities of listed companies. Equity unit trust funds are popular in Malaysia as they provide investors with exposure to the companies listed on Bursa Malaysia. The performance of the units is therefore linked to the performance of Bursa Malaysia. A rising market will normally give rise to an increase in the value of the unit and vice-versa.

Treynor Portfolio Performance Measure

Treynor (1965) develop the first composite measure of portfolio performance that included risk. He postulated two components of risk, risk produced by general market fluctuations, and risk resulting from unique fluctuations in the portfolio securities.

Sharpe Portfolio Performance Measure

Sharpe (1966) likewise conceived of a composite measure to evaluate the performance of mutual funds. The measure followed closely his earlier work on the asset pricing model (CAPM), dealing specifically with the capital market line (CML).

Jensen Portfolio Performance Measure

The Jensen measure (Jensen, 1968) was originally based on the capital asset pricing model (CAPM), which calculates the expected one-period return on any security or portfolio.

CHAPTER 2

LITERATURE REVIEW

From the previous study, its show many researchers have been done on the performance of unit trust. Different researchers have used different model to evaluate performance of unit trust.

STUDIES IN WEST

The earlier research on unit trust’s performance was conducted by Friend et. al. (1962), 152 U.S mutual funds has done analyzed for the period 1953 to 1958 with Standard & Poor indices of five securities as a benchmark. The findings indicated that the mutual funds earned average annual returns (unadjusted risk) lower than the composite benchmark. Besides that, his study consisted of the randomly constructed portfolio of mutual fund in 1965, they concluded that mutual fund have not performed superior to random constructed portfolio. However, the study done by they and friend and Vickers are largely irrelevant to the empirical issue of the quality and values of mutual fund management were commented by Kalman and Jerry (1968).

A new measure for the performance of portfolio by incorporating the fund’s return volatility was suggested by Jack L.Treynor (1965), which is the average excess return on the portfolio. It was simple yet meaningful manner volatility. Similarly, Sharpe (1966) was analyzed on 34 open-end mutual funds in the U.S during the period of 1954 to 1963 and showed that the Sharpe ratio for his sample was lower than the DJIA over the same period. His result was later tested and confirmed by Ippolito (1993) as statistically significant. Sharpe also found that the size of funds per se was not important in predicting future performance and good performance was associated with lower expense ratio.

Treynor and Mazuy (1966) has used 57 mutual funds in U.S for the period of 1958 to 1962 and the result was similar with Shape’s (1966) study that on average the mutual funds could not outperform the market. During longer period of 1945 to 1964, Jensen (1968) studied 115 open-end mutual funds in U.S and used the Standard & Poor’s index of 5000 stocks as proxy for the market portfolio. He developed a performance measure called Jensen’s Alpha to evaluate portfolio manager’s predictive ability of security prices. Based on study, he discovered that on average, fund managers were unable to consistently predict share prices as compared to buy and hold strategy, thus reaffirmed the findings of Sharpe’s and Treynor’s.

The literature on the performance of mutual funds has long standing issues. The issues addressed by previous studies included the risk-return performance, selection and market timing abilities of fund managers and the level of diversification of mutual funds. McDonald (1974) estimated the Sharpe, Treynor and Jensen measured for 123 mutual funds using monthly data for the period between 1960 and 1969. The findings showed that majority of the funds did not perform as well as the New York Stock Exchange (NYSE) index.

Moles and Taylor (1977) further supported the results of Sharpe’s. They conducted a risk-return analysis on 86 funds in U.S covering from 1966 to 1975 and their findings yielded that in most cases, the performance variables of the funds such as number of shares and the size of funds had weak predictive power for the funds’ performance in the subsequent periods. However, Friend et. al. (1970) was a contradictory study which replicated Sharpe’s study with the conclusion of beta concept during the period of 1960 to 1968. This study revealed that the average return of the sample was higher than the market portfolio. Ippolito (1990) also found a different result when reviewing and comparing statistical studies on mutual funds performance for the period of 1962 to 1991. His study discovered that mutual funds showed a better performance compared to market indices. Furthermore, he also found that mutual funds returns are consistent with the funds’ risk-adjusted performance exclusive of expenses and its performance is similar to that of the index portfolio. In 1989, the results supported his previous study on the performance of 143 funds in the U.S over the period of 1965 to 1984. The result showed that mutual funds with higher turnover fees and expenses, earned rates of return sufficiently high to offset the higher charges.

In the U.K, Firth (1977) analyzed the performance of 72 unit trusts for the period of 1965 to 1975. The outcome showed that on average, managers of unit trusts in the U.K have not been able to forecast share prices accurately enough to outperform a simple buy and hold policy. During the period of 1975 to 1993, Bal and Leger (1996) further analyzed the performance of 92 U.K investment trusts using the Sharpe (1966), Treynor (1965) and Jesen (1968) measures of portfolio performance. The results of the study showed that the unadjusted funds performance as a whole outperformed the market. Fletcher (1999) examined the performance of 85 U.K unit trusts with North American investment objectives between January 1985 and December 1996. The study concluded that there was no evidence that U.K and North American unit trusts on average or individually generate significant abnormal returns. They also found that there was no relationship between the charges of the trusts and abnormal performance. Thus, it was suggested that U.K trusts managers exhibited similar performance skills to U.S mutual fund managers.

STUDIES IN SINGAPORE

A study on 19 unit trusts from January 1980 to December 1984 was conducted by Koh and Koh (1987) with the Stock Exchange of Singapore (SES) All Share Index as the proxy for the market portfolio. The results of their study revealed that the returns and risks characteristics of the funds were not fully consistent with their stated objectives. They also discovered that the trusts performance was not consistent over time and they were unable to outperform the market and the funds did not achieve a high degree of diversification.

Koh, Phoon and Tan (1989) studied the performance of four investments funds listed on the Stock Exchange of Singapore, from January 1979 to December 1987, by comparing against the market portfolio proxied by SES Index. They concluded that three out of four unit trusts outperformed the market portfolio even though all of the trusts bear systematic risk close to that of the market portfolio by using Sharpe ratio, Treynor Index and the Jensen alpha to measure the funds performance. They also discovered that there were no significant difference in performance between least aggressive unit trusts and the more aggressive unit trusts.

Koh and Kee (1990) studied on some aspects of the performance of unit trusts in Singapore for the period 1980 to 1984. It showed that the unit trusts in Singapore underperformed the market, poorly diversified and recorded inconsistent performance over time. During the period of January 1986 to December 1990, Lee (1993) showed that all the unit trust funds generally underperformed the market with the performance of 21 unit trust funds. However, their risk profile seemed quite stable during the period under study even though there was lack of consistency in the performance and the ranking of the funds. The systematic risks and the degree of diversification of the funds were found lower than that of the market. Therefore, the author concluded that, the past performance of the funds may not be indicative of future performance though their risk profile was not expected to change drastically.

STUDIES IN MALAYSIA

In the Malaysia context, although there have been many researchers studies related to the investment performance of unit trust funds. Most studies had analyzed on the overall fund performance. The earliest study on unit trusts performance was by Chua (1985). He found that unit trust funds performed fairly consistent and fund managers were able to control risk well. Later studies were provided by Shamser and Annuar (1995), Tan (1995), Annuar et al. (1997), Arbi (1997), Leong (1997), Mohd Nawawi (1999), Shamser et al. (2001), Taib et al. (2002), Soo Wah Low and Noor A. Ghazali (2005), Soo Wah Low (2007), Hussin (2006) and Huson (2007).

Shamser and Annuar (1995) found that average return on Malaysian unit trust funds was below the market average. Hence, they examine that unit trust funds failed to achieve expected level of diversification. In the study by Annuar et al. (1997) gets the similar result regarding the diversification level of unit trust funds which is below expectations. Previous studies also found that fund managers have inferior selection skills and poor market timing abilities (Annuar et al. 2001:139-140; Ahmad & Haron, 2006:121; and Huson, 2007:22-23).

Leong and Aw (1997) studied the performance and ranking of 32 private unit trusts using different market portfolio as benchmarks, the KLCI and the Kuala Lumpur Emas Index (EMAS) during the period from January 1984 to December 1996. The results of the study indicated that the returns of the sample trust portfolios were more sensitive to changes in the returns of the KLCI based on higher beta calculated when using KLCI as the benchmark. However, the EMAS benchmark formed a higher R -square than the KLCI, hence were more diversified.

Leong (1997) examined the performance of 13 unit trusts in Malaysia from January 1992 to December 1996 using KLCI as market’s proxy within the framework of APT and CAPM. The research also attempted to evaluate the trusts’ performance before and after 19 March 1994 when Securities Commission announced the new guidelines and regulations for unit trusts after the stock market crash in1993. The researcher used the funds performance measures such as Adjusted Sharpe Index, Adjusted Jensen Alpha and Treynor Index under the CAPM framework. The findings indicated that most of the unit trusts were superior to the market as compared to second sub-period during the first sub-period and the full period.

The area of Islamic unit trusts performance is also being the focal debate among scholars. The Malaysian Islamic unit trust funds performance was examined by Hanafi (2002), Shariff (2002), Abdul Ghafar and Mohd Saharudin (2003), Zaidi et al.(2004), Kefeli and Zaidi (2006) and Abdullah et al. (2004, 2007). These studies provided some insights on the performance of Islamic unit trust funds in Malaysia by measuring the nature and characteristics of these Islamic trust funds (Bashir, 2009: 135-137).

According to Hanafi (2002), Islamic unit trust funds performed better than the market and the risk-free investments. However, Islamic unit trust funds failed to provide diversification in investment. During the bear period, timing ability showed negative by the fund managers. While study by Zaidi et al. (2003) found that on the average, most of Islamic unit trust funds showed negative return and were underperformed the market. Otherwise, Abdullah et al. (2006) studied that Islamic unit trust funds were not only underperformed the market but showed low level of diversification.

Baharuddin and Azwan (2004) and Abdullah et al. (2007) have done studies about the comparative performance of Islamic and conventional unit trust funds and the result are quite new in Malaysia. Furthermore, Baharuddin and Azwan (2004) examined the return performance between conventional and Islamic funds, to know whether assets allocation types and styles influence the fund’s performance and also to identify whether the fund size and fund age influence the return performance.

Besides that, Abdullah et al. (2007) examined 65 funds where, 14 are Islamic funds by divided into three different periods, which were pre (1992 — 1996), during (1997 — 1998) and post (1999 — 2001) financial crisis to ascertain the impact of the economic conditions on the performance of unit trusts funds. For 10 year period from January 1992 to December 2001, he attempted to find the differences between Islamic and conventional mutual funds in terms of performance in the perspective of Malaysia capital market at of monthly returns adjusted for dividends and bonuses.