Abstract
This paper provides a methodological approach, based on the false discovery rate (FDR) of Barras et al. (J Finance 65(1):179–216, 2010. https://doi.org/10.1111/j.1540-6261.2009.01527.x), by which investors can successfully select winning mutual funds and fund managers in China. Our approach allows investors to distinguish between skilled and lucky mutual funds and fund managers and, using this information, to calibrate the proportion of their portfolio funds that are invested in the market index versus funds invested in skilled mutual funds. This feature in our approach can accommodate unique risk appetites and diversification requirements. When accounting for actual transaction costs which individual and institutional investors face in China, we show that our FDR approach can yield positive and economically significant risk-adjusted returns across various rebalancing frequencies. Our approach fares well when compared with naive historical return-based approaches for ranking mutual funds.
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Notes
As we illustrate later on, investors are free to choose whatever p value thresholds they wish and not necessarily those entertained in our paper.
The URLs for these websites are as follows: finance.sina.com.cn (Sina Finance), www.howbuy.com (Howbuy) and www.cnstock.com (Cnstock). These Chinese websites are, to some extent, comparable to the US version of Jim Cramer's Mad Money (www.thestreet.com) which is used by investors to get buy, hold and sell recommendations on various stocks and funds.
According to the Investment Company Institute (ICI), the total net assets of all mutual funds around the world is estimated to be $40,364,115 (in millions of US dollars) as of the 4th quarter of 2016. Some key worldwide market data statistics on mutual funds is publicly available at https://www.ici.org/research/stats/worldwide.
See the survey results and an accompanying discussion of the questionnaire he gave to participating individual investors on page 220 of Shiller (2015).
According to the United Nations Conference on Trade and Development (UNCTAD), China currently ranks third in the world as the largest foreign direct investment (FDI) recipient to the United States and Hong Kong; see figure I.4. on page 5 of UNCTAD's 2016 World Investment Report: http://unctad.org/en/PublicationsLibrary/wir2016_en.pdf.
These are approximate figures estimated in 2007 by the China Securities Regulatory Commission (CSRC). See Fig. 3.21 on page 270 of the China Capital Markets Development Report published in 2008 by the CSRC (2008). While updated versions of this report have yet to circulate, the 2008 report is available online: https://openknowledge.worldbank.org/handle/10986/12643. In our analysis, we entertain various rebalancing frequencies that are consistent with these holding period durations.
These are approximations. See Fig. 3.23 on page 272 of the China Capital Markets Development Report published by the CSRC (2008). Footnote (4) provides a URL link to this report.
See Fig. 3.24 on page 273 of the China Capital Markets Development Report published by the CSRC (2008). Footnote (4) provides a URL link to this report.
According to Barras et al. (2010), the larger the value for FDR, the more likely it is lucky funds will be included in the test portfolio. Thus, an empiricist faces a tradeoff: a large FDR will grant a larger sample of high performing funds but with a higher likelihood of that sample including lucky funds. On the flipside, a lower FDR decreases the sample but increases the likelihood that the selected funds are truly skilled and not lucky. This is discussed more in the methodological section of our paper.
Since 2001 when the first mutual fund was established, there has been an explosion of funds available in China for investors. As of 2014, the assets under management (AUM) of fund management companies' segregated accounts rose to 1.2 trillion RMB (CSRC 2014).
Size is defined as the market capitalization of tradable A-shares. In China, domestic A-shares are divided into tradable A-shares (which are also called floating A-shares or negotiable A-shares) and non-tradable A-shares. Non-tradable shares are typically held by the government and cannot be traded in the stock market (Firth et al. 2010). Hence, following Hu et al. (2018), in this paper we use the market capitalization of tradable A-shares when measuring firm size.
See the methodology here: http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/Data_Library/det_mom_factor.html.
To select \(\uplambda^{*}\), Barras et al. (2010) use the bootstrapping method proposed by Storey (2002) to minimize the mean squared error of \(\hat{\pi }_{0}\) and argue that empirical results are not sensitive to the selection of \(\lambda^{*}\). Hence, we fix the value of \(\lambda^{*}\) to 0.6 throughout our paper.
We define stock-dominated hybrid funds as funds that maintain an average stock-holding proportion greater than 70% throughout the sample period.
Fund purchase fee typically decreases as the amount of purchase increases. For individual investors who normally invest less than 1 million RMB, the purchase fee is around 1.5%. For more information, please see the transaction cost Sect. 6.1.1.
The reason that we do not focus on the persistence of past poor funds is that almost all of the Chinese mutual funds cannot be shorted due to short selling constraints. Hence, knowing the persistence of past poor funds cannot actually help investors to develop fund selection strategies.
They estimate standard stock selecting and market-timing models using daily mutual fund data and find short-term persistence.
The Hushen 300 ETF is the most popular index ETF in China and is highly liquid. The Hushen 300 ETF was first introduced in May 2012 while, prior to this date, the Hushen 300 ETF in our FDR strategy is replaced by the Shangzheng 50 ETF.
Howbuy.com provides fee information for individual funds. For more information about purchase and redemption fees, please use the following URL link: https://www.howbuy.com/fund/.
Trading ETFs in the stock market is similar as trading stocks. The transaction cost depends on the policy of different brokerage house (security companies in Chinese stock market). For more information about trading ETFs, please use the following URL link provided by Shanghai Stock Exchange (SSE): http://edu.sse.com.cn/invesNetC/data/hai/products/ETF/.
For funds with more than one manager, we have to assume that every fund manager expends the same amount of effort. Similarly, for managers who manage more than one fund simultaneously, we have to assume that they expend the same effort for each of the funds they manage.
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Koutmos, D., Wu, B. & Zhang, Q. In search of winning mutual funds in the Chinese stock market. Rev Quant Finan Acc 54, 589–616 (2020). https://doi.org/10.1007/s11156-019-00800-z
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DOI: https://doi.org/10.1007/s11156-019-00800-z