This thesis undertakes a comprehensive analysis of asymmetric mutual fund performance on U.S. domestic equity funds, represented by nine value-weighted portfolios (based on their stated investment objectives). Daily data from 1st September 1998 to 30th June 2009 are used. In contrast to the bulk of the extant literature which relies a single regime model, this thesis assesses mutual fund performance in terms of stock selectivity, market timing and style timing across different states of the market where states are determined by regime-switching methods. The thesis comprises three related empirical essays. Each essay investigates one aspect of performance as its key focus.
The first empirical essay is presented in Chapter 2. It combines the regime-switching mechanism with the Carhart four-factor framework to model abnormal returns during high- and low-volatility markets. This model is extended by adding dividend yield and term spread as conditional information variables. Volatility is modelled as a generalized autoregressive conditional heteroskedastic (GARCH) process within each regime. In contrast to previous studies, the chapter finds no evidence of abnormal performance in either high- or low-volatility markets when daily returns are used. However, with the use of monthly data, there is evidence that mutual funds at the aggregate level perform better in recession than in expansion periods, which is consistent with previous studies. The results suggest that countercyclical performance found in the existing literature is possibly due to data frequency. On average, institutional funds exhibit greater exposure to size, value and momentum factors than retail funds. The model comparisons show that conditional regime-switching models are not clearly superior to their unconditional regime-switching counterparts.
The second essay is presented in Chapter 3. It addresses market timing issues. This empirical essay uses a GARCH-enhanced regime-switching framework overlayed on the Treynor and Mazuy (1966) unconditional model and the Ferson and Schadt (1996) conditional model. The results show that the regime-switching model captures asymmetric timing performance, whereas single regime models do not. It also shows that fund managers have significant perverse timing attributes in low-volatility markets, but not in high-volatility markets. When applying the conditional regime-switching timing model, there is weak evidence that conditional timing measures make mutual fund managers appear better at timing than they do when unconditional measures are used. On average, institutional fund managers’ timing performance is inferior to that of retail funds. The results are robust across sample periods.
Timing performance is further examined in the third essay, this time with a specific focus on style timing, which is presented in Chapter 4. The purpose of this empirical essay is to investigate the ability of mutual fund managers to alter their exposure to style factors and how their asset allocation decisions evolve over time in response to changing economic and market conditions. Three investment styles, size, value and momentum factors, are incorporated into the regime-switching model. The results show that, at the aggregate level, mutual fund managers exhibit significant negative market timing and value timing, and such perverse timing is largely attributable to the performance in low-volatility markets, rather than in high-volatility markets. The analysis of different fund categories reveals that retail fund managers appear to be less willing to consider style factor timing. It appears that institutional aggressive growth and growth fund managers tilt towards large stocks in low-volatility regimes whereas institutional income funds are more contrarian. The results also suggest that style timing ability can be misidentified as market timing if the timing model focuses only on market timing skills, which offers an alternative explanation to the puzzling empirical issue of perverse market timing.