New Microsoft Office Word Document

THURSDAY, AUGUST 23, 2007
MUTUAL FUNDS IN NEPALESE SECURITIES MARKET
INTRODUCTION
1.1 Background
A security market, or financial market, can be defined as a mechanism for
bringing together buyers and sellers of financial assets in order to facilitate
trading (Sharpe, Alexander & Bailey, p.47). It is recognized as an effective
way of raising capital for commercial enterprises, and at the same time
providing an investment opportunity for individuals and institutions. It
provides mechanism to mobilize community savings for productive
investment. The security market is a requisite for the sound development
of an economy because it not only provides stable long-term capital for
companies and an effective savings vehicle for the public, but also
functions as an efficient tool for resource allocation.
Nepal being one of the least developed countries in the world has to make
every possible endeavour to efficiently mobilize the available capital. The
need for an efficient securities market is a must for the efficient allocation
of capital within economies. Mass participation in country’s
industrialization process is possible only through the efficient mechanism
of securities market as it promotes efficient collection of small and
scattered savings from the investors and provides returns to them in the
form dividend (Adhikari, p.41). Moreover, the financial intermediaries
which link savers at one end and users of capital at the other would be
needed to make the mass participation possible and the securities market
work more efficiently. These intermediaries have knowledge of the

problems of investment and of opportunities of employing funds profitably
which is denied to most individual investors. They can go farther afield
geographically; they know the personal reputation of would-be borrowers;
they command expert advice of the highest quality. In this manner they
can secure a higher return on the savings of individuals owing to superior
knowledge and bargaining power (Grant, A.T.K., p.183).
Mutual funds come right there. Mutual funds are simply a means of
combining or pooling the funds of a large group of investors (Corrado &
Jordan, p.88). Since they provide indirect access to financial markets for
individuals, they are a form of financial intermediary. They represent a
sensible and efficient vehicle for individual investors to participate in the
market (Fisher & Jordan, p.654). Investing in mutual funds, the individual
investor can in effect employ a team of investment professionals to manage
his money under the direction of a portfolio or fund manager. These
individuals work full-time on studying the markets, market trends, and
individual stocks. Also, the fund allows the investor to purchase a very
diversified portfolio of securities for a small investment. It is impossible to
purchase a very diversified portfolio of individual securities with a modest
investment outside of a mutual fund.
Thus, mutual funds could be an admirable institution for bridging the gap
between the individual savers
8/10/2018 Nepal Stock
http://nepalistock.blogspot.com/2007/08/mutual-funds-in-nepalese-securities.html 2/23
In fact, the work has been started. Following are the brief introduction of
the mutual funds established in Nepal so far.

1.2 Concept of Mutual Fund
Basically, a company that pools funds obtained from individual investors
and invests them in the securities market is called an investment company.
In other words, an investment company is a business that specializes in
managing financial assets for individual investors. All mutual funds are, in
fact, investment companies, however, not all investment companies are
mutual funds (Corrado & Jordan, p.89).
There are two primary forms of investment companies: open-end and
closed-end companies.
With an open-end fund, the fund itself will sell new shares to anyone
wishing to buy and will redeem (i.e., buy back) shares from anyone
wishing to sell. When an investor wishes to buy open-end fund shares, the
fund simply issues them and then invests the money received. When
someone wishes to sell open-end fund shares, the fund sells some of its
assets and uses the cash to redeem the shares. As a result, with an openend
fund, the number of shares outstanding fluctuates through time.
With a closed-end fund, the number of shares is fixed and never changes.
If you want to buy shares, you must buy them from another investor.
Similarly, if you wish to sell shares that you own, you must sell them to
another investor.
Strictly speaking, the term “mutual fund” actually refers only to an openend
investment company. Nonetheless, particularly in recent years, the
term “investment company” has all but disappeared from common use and
investment companies are now generically called mutual funds (Ibid.,
p.90).
The mutual fund industry has grown tremendously in the developed
economies, especially the U.S., where they are now the largest type of
financial intermediary, followed by commercial banks and life insurance
companies (Ibid., p.88). The U.S. mutual fund market is the largest in the
world, accounting for half of the $16.2 trillion in mutual fund assets
reported worldwide. In 2004, U.S. mutual fund assets reached a record
$8.1 trillion, while the total U.S.-registered investment companies
managed a record $8.6 trillion at year-end 2004 (ici.org/factbook).
In India, the origin of mutual fund industry is with the introduction of the
concept of mutual fund by Unit Trust of India in the year 1963, by an Act of
Parliament (amfiindia.com). As at the end of September, 2004, there were
29 funds, which managed assets of Rs. 153108 crores under 421 schemes.
Back in our country Nepal, the history of mutual funds started with the
flotation of NCM First mutual fund 2050 by NIDC Capital Markets in 1993
(Shrestha, et. al., p.203). Currently, there are two mutual fund schemes:
NCM Mutual fund 2059, managed by NIDC Capital Markets with NIDC as
the trustee, and Citizen Unit Scheme managed by Citizen Investment
Trust.
1.3 Mutual funds in Nepal
Until now, there are three mutual funds in Nepal. But the NCM First
Mutual fund, 2050 has already been terminated. The NCM Mutual fund,
2059 and the Citizen Unit Scheme are the currently prevailing mutual
funds in Nepal. Brief introductions of these schemes are given below:
1. NCM First Mutual Fund, 2050
With the objective of providing expert investment services, NCM First

Mutual Fund, 2050 an open-end fund with a par value of Rs.10 per unit
was issued in multiple of 100 units by NIDC Capital Markets in the year
1993. Its main features were (Hada, Rabin, 2004):
· The sale of this scheme was made in 17th Ashad 2050 to 11th Bhadra
2050.
· The allotment of this scheme was made in 11th Ashwin 2050.
· After the distribution of Unit Certificate, the buy and sales were made on
the NAV of the First Mutual Fund.
· This scheme was listed according to Security Exchange Act 2040.
· The target was collection of capital will be 100 millions.
· This fund was just an investors’ saving scheme. The investors were the
shareholders of the funds’ assets on the basis of the units the hold.
· The unit price of this fund was Rs.10 and the investors were required to
hold a minimum of 100 units. Investors for wishing to subscribe in
addition to above can hold any without limit.
· The custodian and the banker of the scheme was Nepal Arab Bank Ltd.
· The management company of the scheme was NIDC Capital Market Ltd.
· The expected return of the scheme was 19% annually.
After two years of the introduction, its buying and selling was stopped due
to excessive selling pressure. In order to revive the fund and provide
liquidity, by means of repurchase, Nepal Rastra Bank and Nepal Industrial
Development Corporation injected an amount of Rs.45 million and Rs.15
million respectively in the 1995. The custodian and the trustee of the
scheme was NCML. The fund manager of the scheme was NIDC Capital
Market Ltd. Thereafter, the fund was converted to close-end fund and
listed in the NEPSE. By the end of FY 1999/2000, the fund was in
operation in the market with per unit NAV of Rs.22.15. The scheme was
terminated by the end of fiscal year 2000/2001.
2. NCM mutual fund, 2059
During the termination of NCM First Mutual Fund, 2050, the fund holders
were given option to refund or to participate in another new scheme called
“NCM Mutual Fund, 2059”. All the assets and liabilities of NCM First
Mutual Fund, 2050 was valued on 2058/06/29 and was transferred to
NCM First Mutual Fund, 2059. SEBO approved this new mutual fund on
August 9, 2002. Its basic features are as follows (Prospectus of NCM
Mutual Fund, 2059):
· The scheme is limited to 1 crore units and shall be managed as close-end
fund.
· The pare value of each unit shall be of Rs.10.
· The units issued under this scheme are listed in NEPSE in accordance to
Securities Exchange Act, 2040.
· The scheme is managed by NCML and the trustee is NIDC.
· The management company and the trustee has bought 7.5% each,
collectively 15% of the total issued units and has invested as seed capital in
the fund.
· In order to revive the fund and provide liquidity NRB and NIDC injected
an amount of Rs.45 million respectively in the 1995. After valuation of
assets of NCM First Mutual Fund, 2050, NCML has returned the fund of
NRB. While the funds provided by NIDC as kitty fund has been transferred
to NCM Mutual Fund, 2059 and new units has been issued.
Out of the total units, it distributed 1.5 million units to its management
and trustee, 1.33 million to the unit holders of previous mutual fund
scheme and the remaining 7.17 million units issued to the public. As
published in the annual report 2061/2062 of SEBO, total investment of the
fund reached to 156.49 million.
3. Citizen Unit Scheme, 2052
Citizen Unit Scheme, 2052 with a par value of Rs.100 came into operation
in the year 1995. CIT has been managing this scheme. The scheme is in
operation on income cum growth concept. It is an open-end scheme and
provides regular income in the form of dividend to the unit holders. Its
essential features are: (Prospectus of Citizen Unit Scheme, 2052):
· In order to sustain and increase the confidence of investors and to
simplify the operation of the scheme, until and unless the fund of the
scheme does not reach to a self sustained position, only a minimum
amount of dividend shall be distributed.
· In order to maintain liquidity, the scheme itself has been maintaining the
provision of repurchase. The repurchase price is based on NAV of the
scheme. But until and unless the fund of the scheme does not reach to a
self sustained position, the repurchase price will be equal to par value.
· Since it is a regular income scheme, while investing the funds, proper
consideration has been taken regarding value added income and regular
income.
· As for then, maximum of 30% of the investment shall be on organized
institutions.
· Unless and until there are not sufficient instrument bearing fixed and
regular income in the capital market, the funds allocated to invest on such
instruments shall be mobilized towards advancing short-term loan. But
such investment on advancing short-term loan shall not exceed the funds
invested in the government securities.
· Most of the incomes earned from the Citizen Unit Scheme shall be
distributed as dividends.
· For the calculation of income, the increase in the value of securities has
been converted into income either by handing over or selling it.
As reported in the annual report 2061/2062 of SEBO, by the end of the FY
2061/62, it sold units amounting to Rs. 1215.62 million and repurchased
the units amounting to Rs. 702.53 million. The total number of
participants of the scheme has reached to 10,813 and it had declared to
distribute 7% dividend to its unit holders.
The present study will attempt to explore the prospects and performances
of these two.
1.4 Statement of the problem
The low involvement of institutional investors has been an accepted reality
in Nepalese securities market. It has been also one of the major issues for
the development of securities market in Nepal (Adhikari, 2005). Moreover,
the participation of mutual funds as institutional investors is limited to
only two- NCM mutual fund and Citizen Unit Scheme.

It has been studied that countries having developed securities market
mechanism are developed and countries with poor securities market
mechanism are underdeveloped (Dhungel, 2001). Likely, the part mutual
funds can play in developing the market could be assumed from the fact
that the developed securities market like that of U.S., has the mutual funds
as its largest financial intermediary. So Nepal has the need to push up this
industry.
General investors would be better off by investing in the shares of an
investment company rather than making their own portfolio because of
numerous reasons. The funds have a diversified portfolio, which means
less risk to the investors. Skilled and experienced professionals manage the
mutual funds. Because they are large professionally managed portfolios,
mutual funds incur proportionally lower trading commissions than do
individuals.
In spite of the recent growth in Nepalese securities market after the prodemocracy
movement of 2062/63 and the various advantages of mutual
funds, the success of mutual fund is not noticeable in the country. On the
one hand, huge oversubscription of primary issues and the surging NEPSE
index are being observed while the transaction of mutual funds is quite low
in the market.
In this present context, the study attempts to deal with the followings:
· How do the mutual funds operate in Nepal?
· How have they been performing over the years?

· Are they performing better than the market? Better than naïve
diversification?
· Which of the two funds is performing better in terms of returns to its
investors?
1.5 Purpose of the Study
As already stated, the focus of the study is to assess the mutual fund
industry of Nepalese Securities market. Currently, there are two players:
NCM mutual fund is exactly a closed-end fund and the other Citizen Unit
Scheme has the nature of open-end type. In this aspect, the study takes the
basic purpose to examine the performances of the funds, compare them
with each other, with market’s return as well as with a randomly
diversified portfolio.
Specifically,
· To explore a brief history of Nepalese mutual funds and their operations.
· To examine the performances of the funds with respect to the returns
provided to the investors.
· To evaluate the returns of the funds with respect to market (i.e., NEPSE)
return and a randomly constructed portfolio.
· To compare the performances of the two funds in terms of the returns
provided.
1.6 Significance of the Study
As the objectives set for the study is to examine the performances of the
Nepalese mutual funds, the thesis would be an important paper to deal the
prospects of Nepalese mutual funds.
Nepalese mutual have not really played a significant role in Nepalese

security market as displayed by its minimum share in the market.
Investors also seem to be less interested in these products as the trading at
NEPSE indicates. So, in these perspectives, this study would have
significance to the following stakeholders, to point out:
1. To mutual fund operators: The performances of the mutual funds have
been analysed over the period of operation and the weaknesses of their
operation could be indicated.
2. To general investors: It provides information about Nepalese mutual
fund industry. The literature review would also be of help to general
investors.
3. To regulators of security market: The underperformance of Nepalese
funds could be pointed out from the st
2.1 Conceptual Framework
The concepts dealing with mutual fund and related are discussed here.
Mutual funds are financial intermediaries that pool the financial resources
of investors and invest those resources in (diversified) portfolio of assets
(Saunders & Cornett, 2001, p.502).
By definition, Mutual fund is one type of investment company (Corrado &
Jordan, p.88). At the most basic level, a company that pools funds
obtained from individual investors and invests them is called an
investment company (ibid, p.89). So let us first deal with the term
“investment company.”
2.1.1 Investment Companies

Investment companies are a type of financial intermediary, who obtain
money from investors and use that to purchase financial assets as stocks
and bonds (Sharpe, Alexander & Bailey, p.699). In a way, it is a company
that provides collective investment opportunities to individuals,
businesses and other investors. It is the company which manages a
portfolio of securities of various other companies through the funds
generated from the public by the issue of shares.
Types
There are two fundamental types of investment companies: open-end and
closed-end investment companies.
1. Open-end investment company
With an open-end fund, the fund itself will sell new shares to anyone
wishing to buy and will redeem (i.e., buy back) shares from anyone
wishing to sell. When an investor wishes to buy open-end fund shares, the
fund simply issues them and then invests the money received. When
someone wishes to sell open-end fund shares, the fund sells some of its
assets and uses the cash to redeem the shares. As a result, with an openend
fund, the number of shares outstanding fluctuates through time.
Open-end investment companies are commonly known as mutual funds
(Sharpe, Alexander & Bailey, p. 705). So, strictly speaking, the term
“mutual fund” actually refers only to an open-end investment company.
However, in the recent years, the term “investment company” has all but
disappeared from common use and investment companies are now
generically called mutual funds (Corrado & Jordan, p.90).
In our own country, NCM mutual fund is actually a closed-end investment

company but is named as a mutual fund, so nowadays, the term “mutual
fund” seems to have taken over. It is also likely as mutual funds or openend
investment companies are the most popular form of investment
companies and accounts for nearly 95% of the total investment companies
in U.S. as of 2004 data (ici.org/factbook).
Types of Mutual Funds/ open-end investment companies:
Open-end investment companies can be subdivided into those that charge
a sales fee (load funds) and those that do not (no-load funds). A load fund
charges investors for the costs involved in selling the fund which generally
involves brokerage, insurance expenses, etc. A no-load fund, on the other
hand, sells its shares at a price equal to their NAV as it sells shares directly
to the investors without the use of a sales organization.
Moreover, these-days mutual funds are generally divided into various
categories based upon their stated investment objectives in their
prospectuses. For example, the main types of objectives are growth,
balanced income, and industry-specialized funds. Growth funds typically
possess diversified portfolios of common stocks in the hope of achieving
large capital gains for their shareholders. The balanced fund generally
holds a portfolio of diversified common stocks, preferred stocks, and
bonds with the hope of achieving capital gains and dividend and interest
income, while at the same time conserving the principal. Income funds
concentrate heavily on high-interest and high-dividend-yielding securities.
Bond funds vary also in the average duration of its holdings. Portfolios
with low durations are significantly less sensitive to changes in interest
rates than those with high durations. The industry-specialized mutual fund
obviously specializes in investing in portfolios of selected industries; such a
fund appeals to investors who are extremely optimistic about the prospects
for these few industries and are willing to assume the risks associated with
such a concentration of their investment dollars. Families of funds have
developed that allow investors to switch from a fund with one objective to
a fund (in the same family) with a different objective for a modest fee. An
investor might be motivated to do this as the stock market and interest
rates go through various phases (Fisher & Jordan, p.653).
Likewise, the investment company institute identifies 22 groups of openend
mutual funds, according to the objectives outlined in the prospectus.
They can be broadly aggregated into four groups: equity, bond and equity,
bond, and money market. The ICI data exclude closed-end funds, unit
investment trusts, variable annuities, and unregistered funds (such as
hedge funds).
Equity funds Investing primarily in common stocks with the goal of longterm
growth
Aggressive growth Maximum appreciation with no concern for current
income
Growth Capital appreciation with some concern for current income
Growth and Income Capital appreciation and steady current income
Equity-International Capital appreciation from non-U.S. common stocks
Equity-Global Capital appreciation from both U.S. and non-U.S. stocks
Bond and Equity Funds Investing in a mix of common stocks and longterm
debt with the goal of achieving both long-term growth and income
Equity-Income High income from common stocks with history continuous
dividends
Flexible Portfolio Stocks, bonds, and liquid assets varying with market
conditions
Balanced Capital appreciation, current income, and stability of principal
Income-Mixed High current income from both stocks and bonds
Bond Funds Investing in long-term bonds with the primary goal of income
National Municipal Municipal bonds issued by any or all states
State Municipal Municipal bonds issued by specific states
Income-Bond Mixture of corporate and government bonds
Government U.S. Treasury securities
GNMA Mortgage securities backed by Government National Mortgage
Association
Global Bond Bonds of both U.S. and non-U.S. issuers
Corporate Bond Diversified portfolio of corporate bonds
High Yield Bond Maintain at least 2/3 of assets in non-investment-grade
corporate bonds
Money Market Funds Investing in short-term, highly liquid securities
Tax-Exempt, National Short-term obligations of state and local
governments
Tax-Exempt, State Short-term obligations of state and local governments
within specific states
Taxable Short-term obligations of U.S. government and corporations
2. Closed-end investment companies

With a closed-end fund, the number of shares is fixed and never changes.
If you want to buy shares, you must buy them from another investor.
Similarly, if you wish to sell shares that you own, you must sell them to
another investor.
Closed-end investment companies, unlike mutual funds, usually sell no
additional shares of their own stock after the initial public offering. A
closed-end investment company is more like a traditional, publicly traded
corporation, with a fixed number of shares of common stock outstanding
(Cheney & Moses, p. 120). Their shares are traded either on an organized
exchange or in the over-the-counter market. Thus an investor who wants
to buy or sell shares of a closed-end fund would simply place an order with
a broker (Sharpe, Alexander & Bailey, p. 702).
A closed-end fund can operate as a diversified or a non-diversified fund. A
diversified fund holds a large number of securities from different
industries and thus provides the investor with diversification. In a nondiversified
fund, the portfolio concentrates in specific industry segments
such as petroleum resources or gold-mining issues. Some non-diversified
funds also concentrate in specific types of securities as junk bonds,
convertible bonds, municipal bonds, real estate investment trusts (REITS),
or preferred stock (Cheney & Moses, p. 122).
There are three other types of closed-end investment companies (ibid,
p.123):
1. Unit Trusts: This type of portfolio typically sells for $1,000 known as a
“unit” and that represents a claim to a fixed portfolio of securities. The
securities in the portfolio are purchased and the ratio is fixed before the
units are offered to investors. Since the composition of the portfolio
remains unchanged, no management committee is needed for the trust
after the securities are acquired. Once the initial public offering is made,
the “units” are traded in the OTC market. The number of ownership units
remains fixed as in the case of a closed–end fund.
The portfolio of a unit trust generally consists of fixed-income securities
such as tax-exempt municipal bonds, corporate bonds, or government
securities. The trustee of the portfolio collects all the interest paid on the
bonds and pays to the investors, usually on a monthly basis. When the
bonds mature, the trustee distributes the principal, and the trust
terminates.
2. Dual funds: Closed-end dual fund got its name “dual” since it has two
types of shares, income and capital. The income shareholder has the right
over all interest and dividends, and the capital shareholder receives all the
capital gain distributions.
3. Primes and Scores: Beginning in the early 1980s, a no. of investment
trusts were formed for the purpose of splitting blue-chip common stocks
into conservative and speculative components. A separate trust is created
for each common stock, and the trust creates three different securities:
trust units, primes and scores. The prime (prescribed right to income and
maximum equity) security entitles the holder to all the stock’s price
appreciation above a specified price when the trust is liquidated.
2.1.2 Mutual Fund Operations

A Mutual fund is simply a corporation owned by its shareholders. The
shareholders elect a board of directors; the board of directors is
responsible for hiring a manager to oversee the fund’s operations.
Although mutual funds often belong to larger “family” of funds, every fund
is a separate company owned by its shareholders.
Most mutual funds are created by investment advisory firms, which are
businesses that specialize in managing mutual funds. Investment advisory
firms are also called mutual fund companies. Increasingly, such firms have
additional operations such as discount brokerages and other financial
services.
In U.S., the securities Act of 1933 requires the fund’s shares to be
registered with the Securities and Exchange Commission prior to their
sale. The Securities Exchange Act of 1934 regulates the purchase and sale
of all types of securities, including mutual fund shares. The investment
advisors act of 1940 regulates certain activities of the investment advisers
to mutual funds. The investment company act of 1111984 is a highly
detailed regulatory stature applying to the fund itself. This act contains
numerous provision designed to prevent self-dealing and other conflicts of
interest, provide for the safe keeping of fund assets, and prohibit the
payment of excessive fees and charges by the fund and its shareholders
(Woolfell, Charles J., 1994).
The National Association of Securities Dealers (NASD) imposed new rules
on July 1, 1993 to suppress the unregulated growth of mutual fund sales

charges. The new rules for charges on mutual funds limit 12b-1 fees to
0.75% a year plus a 0.25 % service fee. Limits are also placed on the total a
fund can collect in sales charges to a specified percentage of new sales it
makes. The rules allow a fund with no upfront sales charge and whose 12b1
is not over 0.25%, to refer to itself as a no-load fund (Ibid).
A mutual fund is a fund established in the form of a trust to raise money
through the sale of units to the public or a section of the public under one
or more schemes for investing in securities, including money market
instruments. The regulation of mutual funds operating in India falls under
the purview of the authority of the Securities and Exchange Board of India
(SEBI). Any person proposing to set up a mutual fund in India is required,
under the Securities and Exchange Board of India (Mutual Funds)
Regulations, 1996 (Mutual fund Regulations), to be registered with the
SEBI. The Mutual Fund Regulations lay down several criteria that need to
be fulfilled in order to be granted registration as a mutual fund. Every
mutual fund must be registered with SEBI and must be constituted in the
form of a trust in accordance with the provisions of the Indian Trusts Act,
1882. The instrument of trust must be in the form of a deed between the
sponsor and the trustees of the mutual fund duly registered under the
provisions of the Indian Registration Act, 1908 (www.sebi.gov.in).
Investment vehicles like mutual and unit funds cater to the needs of small
savers and also provide opportunity to gain from investment in the
diversified portfolio of securities. In the context of Nepal, the securities
market had tested a case of mutual fund with the floatation of NCM
Mutual fund, 2050, a closed ended fund with an amount of 100 million
managed by NIDC Capital Markets Ltd. The SEBO/N accommodated the
floatation after making the issue prospectus more transparent. It had also
prescribed for inclusion and acceptance of investor friendly provisions
which include the autonomy of the fund, the fund manager and the
custodian with their clearly defined roles and transparency in the valuation
of assets. Besides the fund should be an earnings cum growth (not growth
scheme alone) and that sponsor should bring in at least 15% corpus to the
fund. However, clear mandate to regulate such a fund was not available to
the SEBO/N and existing legal frameworks too were not sufficient.
Later on, SEBO/N got involved in restructuring of the fund when the fund
could not cope with the liquidity pressure generated by the fund holders,
SEBO/N cooperated to the efforts to rescue the fund and approved
amended prospectus that restructured the fund. The fund size was tuned
to Rs. 52.3 million that was to be retired on July 15, 2001.
The experience encouraged the enactment of Securities Investment Trust
Act, 1997 and SEBO/N got involved in drafting the act. SEBO/N observed
the necessity of drafting an Investment Trust Act to enable the
establishment and operation of trust funds. With a view to give a sound
legal footing and to protect the interest of the investors, the legislation has
provisions regarding the fund management companies and the trustee.
The act enhances transparency and brings the trust fund within the
regulatory domain of SEBO/N (SEBO Nepal –A Five Year Performance
(1993-1998).
NCM Mutual Fund is in operation in accordance to the rules and
guidelines as in its prospectus, while the Citizen Unit Scheme is

administered with reference to Citizen Investment Act, 2047, its bye-laws
and “Nagarik Akanka Yojana Sanchalan Karyabidihi Niyamharu, 2052”.
NCM Mutual Fund is a closed-end fund and the units issued under it are
listed in NEPSE in accordance to Securities Exchange Act, 2040. The
prospectus or the rule book of Citizen Unit Scheme does not mention
whether it is open-end or closed-end. But, looking at its operation it is an
open-end fund. However, its rule number 15 suggests that its unit shall be
listed NEPSE in accordance to Securities Exchange Act, 2040.
The share price of the mutual fund is based on Net Asset Value (NAV
Calculation) per, which is found by subtracting from the market value of
the portfolio the mutual fund’s liabilities and then dividing by the number
of mutual fund shares issued. The sources of income of the funds are
dividends, interests, fees, capital gain distribution and change in the price
of the fund. In case of NCM Mutual Fund, it calculates its NAV each month
considering the average price of shares of its portfolio during the month.
The buying and selling of shares is done in NEPSE. In such circumstances,
when there is high selling pressure, or there is undue effect on its price, or
where there is no regular transactions, the manager and the trustee is
vested with the power to take part in its buying and selling up to 25% to
regularize the transactions in the market. In case of Citizen Unit Scheme,
as per rule number 20, 21, 22, shares shall be bought and sold at NAV, but
the fund also can itself determine the buying and selling price to regularize
its functioning. Therefore, currently, the fund determined its repurchase

price at Rs. 100 plus interest 7%.
NCM Mutual Fund guarantees at least 5% dividend to its shareholders. If
the income of the particular year is insufficient to distribute 5% dividend,
retaining earning will be utilized. In case of absence of retained earning,
5% dividend will be provided adjusting it at the end of its maturity. Rule
number 18 of “Nagarik Akanka Yojana Sanchalan Karyabidhi Niyamharu,
2052” assures 8% dividend to its unit holders for the first three years of its
operation. As per the provision of rule number 26, Nepal government has
fully exempted tax on the returns earned on investment by the scheme.
Further, the unit holders are tax freed up to the investment of Rs. 10000 in
the scheme. Instead of distributing dividends, the fund is providing
interest to the unit holders to take benefit of the rule number 26, which
further exempts tax on the interest provided to its unit holders.
NCM Mutual Fund is a close-end scheme having a life-time of ten years
from its date of issue. In case of arousal of critical situation leading to its
end, the management company can terminate its activities with the
consent of the concerned authorities. Such information will be published
at least in three daily newspapers. In case of liquidation, within three
months of its termination, the money of the investor will be return either
by converting its assets into cash or by issuing certificate of new scheme of
distributing its securities.
The open-end fund, Citizen Unit Scheme is a perpetual scheme. It shall
come to end on such situation when there is a repurchase of more than
75% of the outstanding units. The remaining units shall be purchased back
at the price determined on the basis of valuation of its assets.

In case of amendment of rules and regulations regarding the schemes,
NCM Mutual Fund should take the prior approval of SEBO and publish it
in the paper. While, there is a provision in the Citizen Unit Scheme that the
trust is vested with the power to change its rules and regulation that are
hindering its performance as per rule numbers 27 and 28 and such
changes will be reported through the newspapers.
2.1.3 Performance Measurement
The present study takes the basic purpose of evaluating the performances
of current Nepalese mutual funds. So, related to the portfolio performance
measurement, some terms and concepts are presented next:
(i) Net asset value: Net asset value (NAV) is simply the total market value
of the securities owned, less any liabilities, divided by the number of
shares outstanding (Cheney & Moses, p. 122). For example, an investment
company that holds various stocks traded on a stock exchange (say
NEPSE) could easily find out what the closing prices of those stocks were
at the end of the day and then simply multiply these prices by the number
of shares that it owns. After adding up these figures, the investment
company would subtract any liabilities that it had outstanding. Dividing
the resulting difference by the number of outstanding shares of the
investment company produces its net asset value.
Equivalently, an investment company’s net asset value at the end of day t,
NAVt, can be determined by using the following equation:
where,
MVAt = market value of investment company’s assets
LIABt = amount of investment company’s liabilities
NSOt = no. of shares the investment company has outstanding
(ii) Investor’s return from investing in investment companies:
a. Investor’s return from mutual fund investing:
The investors generally obtain three types of return as a result of owing
shares (units) of a mutual fund:
· Cash dividend or interest disbursements
· Capital gains disbursement
· Change in the fund’s net asset value(NAV) per share
The one period rate of return for a mutual fund share is defined in
following equation:
where,
HPR = Holding period return
NAV = Net assets value
CG = Capital gains
DIV = Dividends
b. Investor’s return from closed-end fund:
Closed –end funds are essentially marketable shares of common stocks. As
a result, their one-period rates of return are calculated like common stock
returns shown by the following equation:
where,
HPR = holding period return
P = price of the fund
CR = cash receipts
(iii) Performance Measurement:
The main idea behind performance measurement is to compare the
returns obtained by the investment manager through active management
with the returns that could have been obtained for the client if one or more
appropriate alternative portfolios had been chosen for investment. The
reason for this comparison is straightforward performance should be
evaluated on a relative basis, not on an absolute basis. In the foregoing
topic, we talked about absolute basis, to get a clear idea about performance
we need to compare with some other portfolio. Such comparison portfolios
are often referred as ‘benchmark portfolio’. Such benchmark portfolios are
usually the stock exchanges. In our case we have taken up the stock
exchange as the benchmark portfolio risk and return. Although return is a
key aspect of performance, some way must be found out to account for the
portfolio’s exposure to risk. Having identified the return it is also essential
to figure out whether the returns were superior or inferior. This could be
done when we estimate the portfolios risk level during the period. The total
risk of a portfolio can be divided in tow parts: the systematic (market) risk
and the unsystematic risk, i.e.,
Total risk = Systematic risk + Unsystematic risk
The first part, systematic risk, is due to risk factors that affect the overall
market- such as changes in the nation’s economy, tax reforms by the
government, or a change in the world energy situation, etc. These are the
risks that affect securities overall and consequently, cannot be diversified

away. In other words, even an investor who holds a well-diversified
portfolio will be exposed to this type of risk.
The second component, unsystematic risk, is unique to a particular
company or industry; it is independent of economic, political, and other
factors that affect all securities in a systematic manner. A wildcat strike
may affect only one company; a new competitor may begin to produce
essentially the same product; or a technological breakthrough can make an
existing product obsolete. For most stocks, unsystematic risk accounts for
60% to 75% of the stock’s total risk or standard deviation. However, by
diversification this kind of risk can be reduced or even eliminated if
diversification is efficient. Therefore, not all of the risk involved is relevant
since part of the risk can be diversified away. The important risk is the
unavoidable or systematic risk (Van Horne & Wachowicz, 2000, p.98)
(iv) Capital Asset Pricing Model (CAPM)
In market equilibrium, a security is supposed to provide an expected
return commensurate with its systematic risk-the risk that cannot be
avoided by diversification. The greater the systematic risk of a security, the
greater the return the investors will expect from the security. The
relationship between expected return and the systematic risk, and the
valuation of securities that follows, is the essence of William Sharpe’s
capital asset pricing model (CAPM). This model was developed in the
1960s, and it has had important implication for finance ever since. The
major assumptions of this model are:
· The markets are efficient. The capital market efficiency implies the share
prices reflect all available information.

· Investors are risk averse. They prefer the highest expected return for a
given level of risk.
· All the investors have homogenous expectations about the expected
returns and risks of securities.
· All investors' decisions are based on single time period.
· All investors can lend and borrow at a risk free rate of interest.
CAPM provides a framework for measuring the systematic risk of an
individual security and relate it to the systematic risk of a well-diversified
portfolio. In the context of CAPM, the risk of an individual security is
defined as the volatility of the securities return vis-à-vis the return of the
market portfolio. The risk (volatility) of individual securities is measured
by beta (β). Beta is a measure of a security's risk relative to the market
portfolio. Since diversifiable risk does not matter, beta is, thus, a measure
of the systematic risk of a security. The market portfolio is the reference
for measuring the volatility of individual risky security. The graphical
representation of the CAPM is called the security market line (SML). The
equation for the SML is:
where,
E(Rj) = the expected return on security j
Rf = the risk free rate
E(Rm) = the expected return on the market portfolio
βj = the un-diversifiable risk of security j
2.1.4 Models of Performance Measurement
The performance evaluation is mainly concentrated to comparison with
the scheme return with benchmark portfolio and risk free return. The
returns are calculated on the basis of month end NAV announced by the
mutual funds. Evaluation can be made on the basis of market prices also.
The returns have been calculated taking month end net asset values since
their commencement to redemption and in the case of the schemes which
are still in operation.
Standard deviation of such monthly returns is to be taken as risk. In order
to obtain the systemic risk of the portfolio CAPM version of market model
is applied. Higher value of Beta indicates a high sensitivity of fund returns
against market returns the lower value indicates a low sensitivity.
Diversification of the portfolio is also one of the major advantages of
mutual fund. Risk can be measured by regressing fund returns with the
market returns. The value of coefficient of determination indicates the
degree of diversification.
The measures that can help to evaluate the performance of portfolio are as
follows:
1. Sharpe Measure
2. Treynor Measure
3. Jensen Alpha
4. Fama Model
5. Appraisal Ratio
6. Fama-French three-factor model alpha
7. CAPM market-timing alpha and gamma
8. Modigliani Measure
9. Morning Star Ratings
10. Carhart 4-factor model
The finance profession has used the first four performance measures for
many years. The Jensen alpha, the Treynor measure and the appraisal
ratio are all rooted in the Sharpe-Linter CAPM, whereas the Fama-French
three-factor alpha is the equivalent of the CAPM-based Jensen alpha in a
multi-factor setting that includes size and book-to-market factors along
with the market factors.
1. Sharpe Measure
William Sharpe has attempted to get a summary measure of portfolio
performance (William F. Sharpe, 1966). The Sharpe Index of desirability,
known as the reward to variability ratio can be used for comparing
portfolios in different risk classes. The Sharpe Index is given by:
where,
Si = Sharpe Index
ri bar =Average Return from Portfolio i
σi = Standard deviation of returns for portfolio i
R = Risk-free rate of interest
Sharpe ratio composite measure of portfolio performance follows closely
from the author’s earlier work on Capital Asset Pricing Model (CAPM). His
procedure involves first subtracting from each portfolio’s net average
return, an estimate of the risk-free rate over the evaluation period. This
difference can be viewed as a risk premium or reward for investing in
assets with more than zero risk. Then each portfolio’s risk premium is
divided by its standard deviation of annual returns, a measure of the

portfolio’s total risk or variability, estimated over the evaluation period.
2. Treynor Measure
The Treynor measure is similar to Sharpe Measure except that it defines
reward (average excess return) as a ratio of CAPM beta risk. Treynor
suggests measuring a portfolio’s return relative to its systematic risk rather
than relative to its total risk, as does the Sharpe measure. This index is
given by the following equation:
where,
Ti = Treynor Index
ri bar = Average return on portfolio i
R =Risk free rate of interest
bi = Beta Coefficient of portfolio i
A key to understanding Treynor’s portfolio-performance measure is the
concept of a characteristic line. The slope of the characteristic line is the
beta coefficient, a measure of the portfolio’s systematic risk. Some people
view systematic risk as a type of volatility measure. Thus, by comparing the
slopes of characteristic lines, the investor gets an indication of the fund’s
volatility. The steeper the line, the more systematic risk or volatility the
fund possesses. Treynor has proposed incorporating these various
concepts into a single index to measure portfolio performance more
accurately.
3. Jensen Alpha
The Treynor and Sharpe Indexes provide measures for ranking the relative
performances of various portfolios, on a risk-adjusted basis. Jensen
attempts to construct a measure of absolute performance on a riskadjusted
basis –that is, a definite standard against which performances of
various funds can be measured. This standard is based on measuring the
“portfolio manager’s predictive ability –that is, his ability to earn returns
through successful prediction of security prices which are higher than
those which we would expect given the level of riskiness of his portfolio.”
Dr. Jensen has modified the characteristic line to make it useful as a one
parameter investment performance measure.
A simplified version of his basic model is given by:
where,
Rit = Average return on portfolio i
Rft = Risk-free rate of interest for period t
αi = Intercept that measures the forecasting ability of the portfolio
manager
βi = A measure of systematic risk
Rmt = Average return of a market portfolio for period t
Higher alpha represents superior performance of the fund and vice versa.
Limitation of this model is that it considers only systematic risk not the
entire risk associated with the fund and an ordinary investor cannot
mitigate unsystematic risk, as his knowledge of market is primitive.
4. Fama Model
The Eugene Fama model is an extension of Jensen model. This model
compares the performance, measured in terms of returns, of a fund with
the required return commensurate with the total risk associated with it.
The difference between these two is taken as a measure of the performance
of the fund and is called net selectivity.
The net selectivity represents the stock selection skill of the fund manager,
as it is the excess return over and above the return required to compensate
for the total risk taken by the fund manager. Higher value of which
indicates that fund manger has earned returns well above the return
commensurate with the level of risk taken by him. Required return can be
calculated as:
where,
Sm = standard deviation of market returns
Rm = Actual return of the fund
Rf = The net selectivity is then calculated by subtracting this required
return from the actual return of the fund.
5. Appraisal Ratio
The appraisal ratio is a transformation of the Jensen’s alpha (Treynor and
Black, 1973). It is the ratio of Jensen’s alpha to the standard deviation of
the portfolio’s non-market risk (i.e., unsystematic risk) as estimated below:
where,
αp = Jensen’s alpha
σ(εp) = standard deviation of the portfolio’s non-market risk
6. Fama-French three-factor model alpha
The Fama-French three-factor model alpha (Fama & French, 1993) is
estimated from the following expanded form of the CAPM regression:
where,
Rpt = Average return on portfolio at time t
Rft = Risk free rate of interest for period t
αp = intercept that measures the forecasting ability of the portfolio
manager
β = A measure of systematic risk
HMLt = high-minus-low book-to-market portfolio return in month t
SMBt = small-minus-big size portfolio return in month t
7. CAPM market-timing alpha and gamma
Henriksson and Merton (1981) model and the quadratic regression of
Treynor and Mazuy (1966) model measure the market timing ability of a
mutual fund manager. The Henriksson-Merton market-timing measure
allows for the beta risk to be different in ex-post up and down markets.
Specifically, the market timing alpha and gamma are given by,
where,
D = Dummy variable that equals 1 for (Rmt –Rft) >0 and zero otherwise.
αp and γp = The market timing alpha and gamma
Under the null hypothesis of no market timing, both alpha p and gamma p
are expected to be zero, whereas a successful market timer’s mutual fund
exhibit positive values of αp and γp.
8. Modigliani Measure
Modigliani and Modigliani (1997) express a fund’s performance relative to
the market in percentage terms and they believe that the average investor
would find the measure easier to understand. The Modigliani measure can
be expressed as follows:
Modigliani and Modigliani propose to use the standard deviation of a
broad-based market index, such as the S&P 500 as the benchmark for risk
comparison, but presumably other benchmarks could be used. In essence,
for a fund with any given risk and return, the Modigliani measure is
equivalent to the return, the fund would have achieved if it had the same
risk as the market index. Thus, the fund with the highest Modigliani
measure, like the fund with the highest Sharpe ratio, would have the
highest return for any level of risk. Since their measure is expressed in
percentage points, Modigliani and Modigliani believe that it can be more
easily understood by average investors.
9. Morning Star Ratings
Morningstar incorporated calculates its own measures of risk-adjusted
performance that form the basis of its popular star ratings. Star ratings are
well known among individual investors. One study found that 90 percent
of new money invested in equity funds in 1995 flowed to funds rated 4 or 5
stars by Morning-star (Damato, 1996).
For the purpose of its star ratings, Morningstar divides all mutual funds
into four asset classes –domestic stock funds, international stock funds,
taxable bond funds, and municipal bond funds. First, Morningstar
calculates an excess return measure for each fund by adjusting for sales
loads and subtracting the 90-day Treasury Bill rate. These load-adjusted
excess returns are then divided by the average excess return for the fund’s
asset class. This can be summarized as follows:
Second, Morningstar calculates a measure of down-side risk by counting
the number of months in which the fund’s excess return was negative,
summing up all the negative excess returns and dividing the sum by the
total number of months in the measurement period. The same calculation
of average monthly under-performance is then done for the fund’s asset
class as a whole. Their ratio constitutes Morningstar risk:
Third, Morningstar calculates its raw rating by subtracting the
Morningstar risk score from the Morning-star return score. Finally, all
funds are ranked by their raw rating within their asset class and assigned
stars as follows: top 10 percent -5 stars; next 22.5 percent -4stars; middle
35 percent -3 stars; next 22.5 percent -2 stars; and bottom 10 percent -1
star. Stars are calculated for three-, five-, and 10-year periods and then
combined into an overall rating. Funds with a track record of less than
three years are not rated. In addition to its star ratings, Morningstar also
calculates category ratings for each fund. The main difference between
stars and category ratings is that category ratings are not based on four
asset classes but on more narrowly defined categories, with each fund
assigned to one (and only one) category among 44 altogether: 20 domestic
stock categories, 9 international stock categories, 10 taxable bond
categories, and 5 municipal bond categories. In addition, category ratings
are not adjusted for sales load and are calculated only for a three-year
period.
10. Carhart 4-factor model with time-varying betas
It is well known that biases can arise if managers trade on publicly
available information, in other words if dynamic strategies are employed.

Average alphas calculated using a fixed beta estimate for the entire
performance period is highly unreliable if expected returns and risks vary
over time. Therefore, Carhart 4-factor model with time-varying betas
comes to rescue. It is given by
where, Zt-1 is a vector of lagged pre-determined instruments. Assuming
that the beta for a fund varies over time, and that this variation can be
captured by a linear relation to the conditional instruments, then beta it
=beta i0 + B ‘i Zt-1, where B ‘i is a vector of response coefficients of the
conditional beta with respect to the instruments in Zt-1.
Among the above performance measures, two models namely, Treynor
measure and Jensen model use systematic risk based on the premise that
the unsystematic risk is diversifiable. These models are suitable for large
investors like institutional investors with high risk taking capacities as they
do not face paucity of funds and can invest in a number of options to dilute
some risks. For them, a portfolio can be spread across a number of stocks
and sectors. However, Sharpe measure and Fama model that consider the
entire risk associated with fund are suitable for small investors, as the
ordinary investor lacks the necessary skills and resources to diversify.
Moreover, the selection of the fund on the basis of superior stock selection
ability of the fund manager will also help in safeguarding the money
invested to a great extent. The investment in funds that have generated big
returns at higher levels of risks leaves the money all the prone to risks of
all kinds that may exceed the individual investors’ risk appetite.
The finance professionals have used the Sharpe measure, Jensen alpha,
Treynor measure and appraisal ratio performance measures for many

years. The Jensen alpha, the Treynor measure and the appraisal ratio are
all rooted in the Sharpe-Linter CAPM, whereas Fama-French three-factor
alpha is the equivalent of the CAPM-based Jensen alpha in a multiplefactor
setting that includes size and book-to-market factors along with the
market factor. To evaluate market timing, CAPM-based market-timing
alpha and gamma and Fama-French three-factor model-based timing
alpha and gamma are used (Kothari and Warner, 2001).
2.2 Review of past studies:
Review of past studies is important to gain knowledge on the status of the
field of the study. It helps to discover what other research in the areas of
the study has uncovered. The following section tries to present the most
important research works that have been carried out in the area of
investment companies:
The first empirical analysis of mutual funds performance is provided by
Friend, Brown, Herman & Vickers in 1962. Because of the growing
importance of investment companies in the United States, the Securities
and Exchange Commission (SEC) engaged the Wharton School of Finance
and Commerce to conduct a study of mutual funds (Fisher & Jordan, p.
672)
The investigation found no relationship between the performance of
mutual funds studied and sales charges that these funds levied. “The fact
that the analysis does not reveal a significant relation between
management fees and performance indicates, in other words, that

investors cannot assume the existence of higher management fees implies
that superior management ability is thereby being purchased by the funds
(Ibid).”
Next, the studies conducted on various dates have been presented
chronologically:
Treynor’s study (1965)
In 1965, Jack Treynor presented a paper in the Harvard Business Review
titled “How to rate management of investment funds” (Treynor, 1965,
p.63-65). He made a comprehensive study on the performance of mutual
funds. He devised an index in order to rank the performance of funds. To
do so, he used the systematic risk, measured by the beta of the fund, rather
than the total risk. Thus, Treynor’s index, Tp, is equal to:
where,
Excess Return (Risk premium) = Average Return – Risk less rate
He found out from his study that the funds were not as superior performer
as the market portfolio.
Sharpe Study (1966)
In order to measure the performance of mutual funds William Sharpe
devised an index of portfolio performance, denoted St, that is defined in
equation below for portfolio i (Sharpe, 1966, p. 125.).
Sharpe gathered data on the risk and return of 34 mutual funds for a
decade and ranked their performance. The Dow Jones Industrial Average
(DJIA) was used as a standard of comparison in evaluation of the
performance of the funds. Out of the 34 funds, 12 had risk-premium to risk
ratios above the 0.667 of the DJIA. The average of the 34 mutual funds
ratio was 0.633 which was below the DJIA’s 0.667. Sharpe concluded that
DJIA was more efficient portfolio than the average mutual fund in the
sample.
Jensen's Study (1968)
Dr. Michael C. Jensen modified the characteristic regression line to make
it useful as a one-parameter investment performance measure. ( Jensen,
“The performance of Mutual Funds in the period 1945-1964”, Journal of
Business, May 1968, vol. XXIII, No. 2, p. 386-416.). Unlike Treynor &
Sharpe, who provided relative performance measures, Jensen constructed
a measure of absolute performance on a risk-adjusted basis, i.e., a definite
standard against which performance of various funds can be measured.
The basic random variables in Jensen’s model are risk premium, as shown
in the equation below:
rpi,t = ri,t - Rt
where,
rpi,t = Risk premium for asset i in period t
ri,t = one period rate of return from asset i in period
Rt = risk less rate observed in period t.
Jensen concluded that the funds in his study were on average not able to
predict security prices well enough to outperform a buy-the-market and
hold policy, but also that there is very little evidence that any individual
fund was able to do significantly better than that which we expected from
mere random chance. Jensen found that the funds earned (net expenses)
about 11% less per year (compounded continuously) than they should earn
given their level of systematic risk.
McDonald’s Study (1974)
Using 120 monthly rates of return from a decade, John G. McDonald
analyzed the performance of 123 mutual funds. The Sharpe & Treynor
performance measure were used but in the slightly reformulated manner.
Dr. McDonald used monthly observations of the 30 days commercial paper
rate as a surrogate for the risk less rate. These monthly observations of Rt
were subtracted from each portfolio monthly rates to obtain monthly risk
premium, denoted rpi,t - Rt. Then the average risk premium, denoted E
(rpi,t - Rt), over the 120 months was divided by the appropriate risk
measure to compare the portfolios performance.
McDonald found that, on average the funds with more aggressive
objectives took more risk and earned higher return. Concerning the
investment performance of 123 mutual funds, McDonald’s study reported
that slightly over half the 123 mutual funds (i.e., 67 out of 123 had values
for Treynor’s performance index that exceeded the stock market average.
Use of Sharpe’s performance measure showed that about 31.7% of the
funds outperformed the stock market average. Thus, using a slightly
different specification of the Sharpe & Treynor’s portfolio performances
measures and a different sample didn’t yield any significant differently
conclusion. The study concluded that on average mutual funds performed
about as well as a naïve buy-and-hold strategy.
Guy’s Study (1978)
James R. F. Guy conducted the performance of the British investment

trust industry (Guy, 1978, p. 443-455.). The paper investigates a sample of
47 British closed-end investment trusts over the interval 1960-1970. Using
the traditional performance measure of Jensen, Treynor & Sharpe, it was
found that no trust in any of the intervals studied had performance
measure that was significantly different from zero. Guy stated that it either
meant that the test was not powerful enough to identify any superior
performance if it existed, or that no trust significantly outperformed
London Stock Exchange, which was the benchmark portfolio used.
The study also investigated two other performances measure: the first
involved an empirically estimated security market line and the second the
zero beta form of the capital asset pricing model. In both cases some
significant measures of performance were obtained. On investigating
whether the performance measures abstracted form beta, it was found that
whereas the new measures were related to beta the effect in the case of the
tradition measures was insignificant.
Hendricks, Jayendu and Zeckhauser’s Study (1993)
One of the important recent studies made on mutual fund performance is
the one made by Hendricks, Jayendu and Zeckhauser (Hendricks, Patel &
Zechkauser, 1993). The research was supported by grants from the Bradley
Foundation & the Decision, Risk & Management Science Program of the
National Science Foundation.
The study carefully examined the quarterly excess returns of 165 mutual
funds from 1974 through 1988 in order to see whether funds with
relatively high returns in one period tended to have primarily in common
stocks with the objectives of growth, growth and income, or income and
aggressive growth.
In the study each fund was placed in one of the eight groups based on the
excess returns over the first quarter of 1974. Then the excess return of each
group was measured for the second quarter of 1974 by averaging the excess
returns of the funds in that group. The process was then repeated, except
that the funds was assigned to one of the eight groups based on their
quarterly excess returns for the second quarter of 1974, and then the
average fund excess return was for each group was calculated for the third
quarter of 1974. This process was repeated through the fourth quarter of
1988, re3sulting in a set of quarterly excess return for each group ranging
from the second quarterly returns for the eight groups were calculated over
the entire period.
The study found out that mutual funds that did better in one quarter were
likely to do better in the next quarter. The study also suggested that
investors should be concerned with short-term relative performance based
on the funds return over the past four quarter. Similar results were
obtained when various risk-adjusted measures of performance, such as expost
Alphas, were used.
Malkiel’s Study (1995)
The performance of equity mutual funds was analyzed by Burton G.
Malkiel. (Malkiel, 1995, p.549-72). The study takes a new look at mutual
funds returns during the 1971 to 1991 period and utilizes a data set that
includes the returns from all mutual funds in existence in each year of the
period. Most data sets included all mutual funds that were in existence and
thereby excluded funds that had terminated their operations. The study
utilized two market indexes as benchmark portfolio: one was Standard &
Poor’s 500 index and the other was Wilshire 5000.
The study utilized the CAPM model to have a measure of the funds
performance shown as below:
Rfd –Rf =α+ β(Rmkt –Rf ) + Efd
where,
Rfd = Funds returns
Rmkt = Market return
Rf = Risk-free return
α is an intercept and β is beta which measures the risk. Positive α implies
positive risk adjusted return.
The calculation used quarterly returns for the funds and for the market
benchmark. The risk free rate taken was three-month Treasury bill rate
reported by Ibbotson Associates. The study also took up an important
issue: Survivorship Bias. It states that significant biases can be created in a
study by including funds that no longer exits. Therefore the study tried to
reduce their biasness by including funds that were in existence. The study
found out that mutual funds tended to under perform the market, not only
after management expenses have been deducted, but also gross of all
reported expenses except load fees.
The study found out, by utilizing simulation of variety of feasible
investment strategies based on the persistence phenomenon, that above
average returns were produced during the 1970’s. During the 1980’s,
however, the study found no evidence that investors could earn
extraordinary returns following a strategy based on persistence.
In conclusion, the study stated that, it did not find any reason to abandon a
belief that securities market is remarkably efficient. It suggested that most
investors would be considerable better off by purchasing a low expense
index fund, than by trying to select an active fund, than by trying to select
an active fund manager who appears to process a hot hard. Since active
management generally fails to provide excess returns and tends to
generate greater tax burdens for investors the advantage of passive
management holds a fortiori.
The findings, among others, were:
· In an aggregate, funds have underperformed benchmark portfolios both
after management expenses and even gross expenses.
· The average alpha is negative when net returns are used and positive
when gross returns were used, but neither is significantly different from
zero.
· While considerable performance persistence existed during the 1970s,
there was no consistency in fund during the 1980s.
· Funds betas and returns were not related as the CAPM suggest.
Likewise, Brown and Goetzmann (1995) analyzed the performance of
mutual funds in USA in terms of returns, number of mutual funds
established, and their total capitalization. They compared the returns of
mutual funds with the returns of S&P 500. Their findings, among others,
were that the mean returns on mutual funds during 1976 to 1988 were
14.5% which was higher than that of S&P 500 during same period. The
capitalization of the funds increased from $37,218 million in 1976 to
$166,474 million in 1988. The number of funds also increased from 372 to
829 during period. They, at the end, concluded that relative risk adjusted
performance of mutual funds persists.
Mark M. Carhart (1997) in his article “On Persistence in Mutual Fund
Performance” in the Journal of Finance took the objective of studying the
persistence of mutual fund performance. Two models of performance
measurement were used. The first was CAPM as described by Sharpe and
Lintner; the other was his own Carhart 4-factor model. The mutual fund
database covered diversified equity funds monthly from Jan. 1962 to Dec.
1993. The data are free of survivor bias, since they include all known equity
funds over this period. Using the sample free of survivor bias, he
demonstrated that common factors in stock returns and investment
expenses almost completely explain persistence in equity mutual funds’
mean and risk-adjusted returns. The results did not support the existence
of skilled or informed mutual fund portfolio managers.
He had also provided three important rules-of –thumb for investors:
1.Avoid funds with persistently poor performance. 2. Funds with higher
returns last year have higher-than-average expected returns next year, but
not in years thereafter. 3. The investment costs of expense ratios,
transaction costs, and load fees all have a direct, negative impact on
performance (Carhart, 1997, p. 57-82)
Mark Grinblatt and Sheridan Titman in their article “The Persistence of

mutual fund performance” (1992) have analyzed how mutual performance
relates to past performance. The tests were based on a multiple portfolio
benchmark that was formed on the basis of securities characteristics. The
evidence found was that differences in performance between funds persist
over time and that the persistence was consistent with the ability of fund
managers to earn abnormal returns.
They used the mutual fund data, consisting of monthly cash-distribution
adjusted returns and investment goals for 279 funds that existed from
Dec.31, 1974 to Dec. 31, 1984. The results indicated that there was positive
persistence in mutual fund performance. The persistence cannot be
explained by inefficiencies in the benchmark that are related to firm size,
dividend yield, past returns, skew-ness, interest rate sensitivity, or CAPM
beta. They asserted that the past performance of investors who are
considering an investment in mutual funds.
Similarly, Kothari, S. P. and J. Warner (2001), in their article, “Evaluating
mutual fund performance”, have studied standard mutual fund
performance measures, using simulation procedures combined with
random and random-stratified samples of NYSE and AMEX securities.
They have tracked simulated fund portfolios over time. These portfolios’
performance is ordinary and well-specified performance measures should
not indicate abnormal performance. The main result is that the
performance measures are badly mis-specified. Regardless of the
performance measure, there were indications of abnormal fund

performance, including market timing ability, when none exists.
They had constructed a 50-stock mutual fund portfolio each month from
January 1964 through December 1991 and have tracked these 336
simulated mutual fund portfolios’ performance over three-year periods
(months 1 through 36) using a number of performance measures, namely,
Sharpe measure, Jensen Alpha, Treynor measure, and the appraisal ratio,
and Fama-French Three factor model alpha.
From the simulations, the main message that had been derived was that
standard mutual fund performances were unreliable and could result in
false inferences. In particular, it was easy to detect abnormal performance
and market-timing ability when none exists. The results showed that the
range of measured performance is quite large even when true performance
was ordinary. It provides a benchmark to gauge mutual fund performance.
Comparisons of the numerical results with those reported in actual mutual
fund studies raises the possibility that reported results are due to
misspecification, rather that abnormal performance.
Finally, the results have indicated that procedures based on the FamaFrench
3-factor model are somewhat better than CAPM based measures.
This is not surprising, and indicates that “style” analysis is useful in
benchmarking fund returns. The misspecification even for Fama-French
suggests at least two possibilities. One is that size and book-to-market do
not completely describe the characteristics relevant for expected returns.
The second is related to the estimation process, and that sampling
distributions of the performance measures differ from those assumed
under null hypothesis, for example because expected returns change

overtime. Further investigation of the latter possibility could be
particularly fruitful in explaining why the tests using simulated portfolios
often show market timing when none is present.
Kurian, A.P. (2004) provides an insight on Indian Mutual Fund Industry
through his article entitled, “On a Growth Trajectory”, in the “Analyst”, vol.
X, issue-7. Mutual funds industry is undoubtedly one of the fastest
growing industries particularly in the financial sector. Looking at the last
ten years, the compounded annual growth rate is around 10% and
similarly in the last 11 years it is about 11-12% per annum. This reflects
how consistently they are growing and this will be further accelerated as
they go ahead.
Back to our own country, Suman Neupane (2001), in his dissertation
entitled, “A Study of Mutual Funds Performance in Nepal”, dealt with the
following problems:
· Why were the investors shying away from investing in mutual funds?
· What was the performance of the mutual funds in the country in terms of
risk-adjusted return?
· Were the mutual funds generating returns in excess of market returns?
· Was there a need of a mutual fund (or investment company) in country
like ours?
· Which of the funds generated higher returns?
With due consideration to the problems, the objectives of his study was set
as follows:
· To find out the performance of the mutual funds currently operating in
the country in terms of risk-adjusted returns.

· To figure out whether the funds have been able to outperform the market
portfolio in terms of risk-adjusted returns.
· To find out as to which of the two funds performed better during the
period studied in terms of risk-adjusted returns.
His study resulted that the NCM Mutual Fund was not as efficient as the
Market Portfolio. CIT seems to be a better performing fund than the NCM
mutual fund on the basis of the annual rates of return. In addition, he
came up with several deficiencies in the practice of mutual funds in Nepal.
The deficiencies range from passive investment strategy adopted by funds
managers to the repurchase of units at par value rather than at NAV.
In the same year, Braja Mohan Adhikari conducted a research in mutual
funds and the results are presented in his dissertation “A financial study of
mutual fund companies in Nepal: A comparative study of Citizen
Investment Trust and NIDC Capital Markets Ltd.”. He took the following
objectives of exploring the profitability condition of CIT and NCM fund,
the condition of their investment portfolio, the condition of their
expenditure portfolio and the financial strengths and weaknesses. The
methodologies taken were the financial analysis, Student’s t-test,
correlation analysis and the trend analysis. His findings, among others,
were:
· Analyzing the schemes of the two companies, the unit trust scheme of CIT
was giving high yield, low risk and more liquidity than that of the NCM.
· EPS of both were fluctuating, however, the profitability condition was

satisfactory.
However, the thesis was not devoted at finding out the performances
aspect of the funds with regard to the performance evaluation tools.
Mahato, Srijana (2002), in her dissertation, “Risk and Return Analysis of
investing in Mutual Fund” had laid following objectives:
· General idea and practice of mutual funds in Nepal.
· Performance of the mutual funds in current status.
· To find out whether investing in share is better or in fund.
· To know why people are not showing interest towards mutual funds.
With regard to above objectives, following research questions were set:
· Why investors are shying away from mutual funds?
· Why it had not been as successful as its counterparts in India or in
developed country?
Her study had revealed that condition of Mutual Fund was not very good.
One of the major reasons for it was the inadequate knowledge about the
features and operations of the mutual funds. NCM Mutual fund was risky
than the market and was not as efficient as the market portfolio. Investors
were shying away from the because of less return and high risk in
comparison to the market. So, she concluded, investing in share was better
than in the fund.
Hada, Rabin (2004) in his dissertation, “Mutual fund: An Emerging Trend
in Nepalese Financial Market” had set following objectives:
· To examine the need and significance of mutual fund for Nepalese
economy.
· To examine the steps taken by government to introduce mutual funds in

Nepalese stock market.
· To explore the current problems being faced by the mutual funds and the
performances in Nepalese market.
Above objectives were set on the ground of the following problems:
· Why was mutual fund needed especially in Nepalese market?
· What are the advantages and disadvantages of mutual fund?
· How mutual funds make investment less risky?
· What are the current problems of mutual fund?
· Does mutual fund help to increase the habit of investment of people?
· How far it is relevant in the Nepalese financial market?
His study revealed that the lack of financial knowledge, proper
government policy and efficient management had led to poor popularity of
the concept of mutual fund among general public.
Sthapit, Anubrata (2004) in her dissertation “Mutual funds and Securities
Markets in Nepal” had set the following objectives:
· To examine the role of mutual funds in the securities market of Nepal.
· To evaluate the performance of mutual funds.
· To find out the reasons affecting the performances of mutual funds in the
securities market.
Older Post
With the help of both primary and secondary data, she concluded that the
existence of Mutual fund in the Nepalese security market was very
nominal, as the market capitalization was very low. Citizen Unit Scheme
had concentrated its investment in government securities while NCM
Mutual fund had focused on shares. So, the change in market prices of the
shares had more effect on it than the CIT and likewise, it seemed more
risky than Citizen Unit Scheme and the market. Through the primary data
analysis, Sthapit concluded that the management was alleged by the public
for the poor performances of NCM fund and similarly, the study showed
that since people considered risk and return as the main factors in making
investment choice, Citizen Unit Scheme had been favoured to NCM mutual
fund, as the former was less risky than the latter.

New Microsoft Office Word Document

Enviado por

Dados do documento

Direitos autorais

Formatos disponíveis

Compartilhar este documento

Compartilhar ou incorporar documento

Opções de compartilhamento

Você considera este documento útil?

Este conteúdo é inapropriado?

Direitos autorais:

Formatos disponíveis

New Microsoft Office Word Document

Enviado por

Direitos autorais:

Formatos disponíveis

THURSDAY, AUGUST 23, 2007

MUTUAL FUNDS IN NEPALESE SECURITIES MARKET

A security market, or financial market, can be defined as a mechanism for

bringing together buyers and sellers of financial assets in order to facilitate

trading (Sharpe, Alexander & Bailey, p.47). It is recognized as an effective

providing an investment opportunity for individuals and institutions. It

provides mechanism to mobilize community savings for productive

investment. The security market is a requisite for the sound development

of an economy because it not only provides stable long-term capital for

functions as an efficient tool for resource allocation.

every possible endeavour to efficiently mobilize the available capital. The

of capital within economies. Mass participation in country’s

industrialization process is possible only through the efficient mechanism

of securities market as it promotes efficient collection of small and

form dividend (Adhikari, p.41). Moreover, the financial intermediaries

work more efficiently. These intermediaries have knowledge of the

which is denied to most individual investors. They can go farther afield

geographically; they know the personal reputation of would-be borrowers;

can secure a higher return on the savings of individuals owing to superior

knowledge and bargaining power (Grant, A.T.K., p.183).

combining or pooling the funds of a large group of investors (Corrado &

individuals, they are a form of financial intermediary. They represent a

sensible and efficient vehicle for individual investors to participate in the

investor can in effect employ a team of investment professionals to manage

his money under the direction of a portfolio or fund manager. These

individuals work full-time on studying the markets, market trends, and

diversified portfolio of securities for a small investment. It is impossible to

purchase a very diversified portfolio of individual securities with a modest

investment outside of a mutual fund.

between the individual savers

8/10/2018 Nepal Stock

the mutual funds established in Nepal so far.

Basically, a company that pools funds obtained from individual investors

and invests them in the securities market is called an investment company.

In other words, an investment company is a business that specializes in

fact, investment companies, however, not all investment companies are

mutual funds (Corrado & Jordan, p.89).

There are two primary forms of investment companies: open-end and

fund, the number of shares outstanding fluctuates through time.

investment company. Nonetheless, particularly in recent years, the

investment companies are now generically called mutual funds (Ibid.,

financial intermediary, followed by commercial banks and life insurance

reported worldwide. In 2004, U.S. mutual fund assets reached a record

$8.1 trillion, while the total U.S.-registered investment companies

managed a record $8.6 trillion at year-end 2004 (ici.org/factbook).

Parliament (amfiindia.com). As at the end of September, 2004, there were

the trustee, and Citizen Unit Scheme managed by Citizen Investment

1.3 Mutual funds in Nepal

funds in Nepal. Brief introductions of these schemes are given below:

1. NCM First Mutual Fund, 2050

With the objective of providing expert investment services, NCM First

1993. Its main features were (Hada, Rabin, 2004):

· The allotment of this scheme was made in 11th Ashwin 2050.

the NAV of the First Mutual Fund.

· This scheme was listed according to Security Exchange Act 2040.

· The target was collection of capital will be 100 millions.

hold a minimum of 100 units. Investors for wishing to subscribe in

addition to above can hold any without limit.

· The expected return of the scheme was 19% annually.

to excessive selling pressure. In order to revive the fund and provide

liquidity, by means of repurchase, Nepal Rastra Bank and Nepal Industrial

Development Corporation injected an amount of Rs.45 million and Rs.15

listed in the NEPSE. By the end of FY 1999/2000, the fund was in

terminated by the end of fiscal year 2000/2001.