Do Mutual Funds Reward Downside Risk? Evidence from an Emerging Economy

Pankaj K. Agarwal and H. K. Pradhan ()
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Pankaj K. Agarwal: Indian Institute of Management Jammu, Old University Campus, Canal Road, Jammu-180016, India
H. K. Pradhan: XLRI Xavier School of Management, C. H. Area (East), Jamshedpur - 831001, India

Review of Pacific Basin Financial Markets and Policies (RPBFMP), 2023, vol. 26, issue 02, 1-34

Abstract: The increasing participation of retail investors — generally having limited risk bearing ability — in mutual funds, has surprisingly not motivated rigorous examination of downside risks-forward return relationship of these funds, which this study aims to accomplish.We use a survivorship-bias free database of returns and portfolio holdings of Indian equity mutual funds covering the period April 2008–November 2018 with Cornish–Fisher expansion of Value-at-Risk (VaR) as a measure of downside risk to examine downside risk-forward return relationship controlling for the fund characteristics such as age, size and style. To complete the story, we also test for the presence of Downside Risk Timing (DRT) ability of fund managers.We find that downside risk does predict future returns of mutual funds and the result holds across different fund sizes, age and styles, particularly strongly in large and midcap style. We also find that the fund manager of the median fund exhibits positive DRT at the 1- and 6-month horizons and negative at the 3- and 12-month horizons. The mixed evidence on DRT suggests that fund managers either did not possess the requisite risk-timing ability or had failed in its application. Findings have important implications for both investors and fund managers.

Keywords: Downside risk; value at risk; downside risk timing; mutual funds performance (search for similar items in EconPapers)
Date: 2023
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DOI: 10.1142/S0219091523500054

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