Determinants in Fund Performance - Paper on Investments

Funds' performance is determined by various factors. These factors include risk, transaction costs, size of the fund and country characteristics. These factors are critical in the operations of the fund as they determine the effectiveness and proper use of the funds in the long run. Major investments decisions are based on risks. Incorporating risk variables when making an investment decision is of substantive importance (Gallagher, 2005). The risk is perceived as the variation in the distribution of various possible outcomes, likelihoods and their subjective values (Awan, D. M., & Arshad, S. 2012). Taking the right risk is key to ensuring that funds perform well and possibly boost the economy as well as the operations of organizations. Risk, therefore, raises or reduces fund performance.

The more investors get attracted to a particular fund; the management gets an opportunity to handle a huge amount of cash. This is accompanied by the challenge on how to put the amount to work with immediate effect (Tompkins, 2004). In the process of finding how to put the cash to work, management a times purchase additional equipment that sometimes is not optimal for the investor's funds. Small funds are easily placed in best ideas, lack of liquidity forces huge funds to be invested in not-so-good ideas. This may take larger positions in terms of stock than is optimal, hence eroding performance (Massa, 2006). Mixed evidence has been tabled to cement the fact that fund returns do decline with the size of the fund. However, it's imperative to point out that there isn't consensus on this issue.

Transaction costs are crucial in determining the performance of funds. Mutual funds do earn positive risk-adjusted returns in a consistent manner; however, significant variations have been documented in risk-adjusted returns across funds. These differences are basically because of the difference in fund fees (Massa, 2006).

Research on mutual funds has tried explaining if the cross-sectional variation in performance that it isn't attributed to funds fees can be attributed to the presence of superior managers with excellent stock picking skills (Gozbathy & Cytak, 2010). Services provided to the Investors are paid by the fund in mutual fund fees. Since their main service is portfolio management, fees are supposed to reflect or show funds risk-adjusted performance. Funds that have worst past performance faces less elastic demand and charge higher fees (Cytak, 2010). This is triggered by the action of investors who are performance sensitive and do not tolerate poor performing funds. Investors avoid poor performing funds to prevent foreseeable losses because their main objective is to make profits.

Fund performance is also determined by the country characteristics. For instance, mutual fund performance is explained by country characteristics beyond fund attributes (Gozbathy & Cytak, 2010). The level of financial development of a country shares a positive relationship with mutual fund performance. This is specific to countries with absolutely high trading activities and low transaction costs. Countries with good level of economic development make it possible for their domestic funds to perform (Simonov, 2006). This is shown in foreign funds performance. They obtain good performance by investing in countries that share a common language and are geographically close. The geographical position of countries facilitates businesses among close countries thus enabling funds to perform well as there is a mutual understanding to do business (Simonov, 2006). This is also facilitated by the creation of a conducive working environment by the governments.

References

Awan, D. M., & Arshad, S. (2012). Factors Valued By Investors While Investing In Mutual Funds - A Behavioral Context. Interdisciplinary Journal Of Contemporary Research In Business, 4(1).

Filbeck, G., and D. Tompkins, 2004, Management tenure and risk-adjusted performance on mutual funds, The Journal of Investing 13, 7280

Gallagher, D., and K. Martin, 2005, Size and investment performance: A research note, Abacus 41, 5565.

Gozbathy, O., & Cytak, L. (2010). An Evaluation of the Attributes Considered by Investment Professionals in Selecting Mutual Funds: The Case of Turkey. International Research Journal of Finance and Economics(36).

Massa, M., and A. Simonov, 2006, Hedging, familiarity and portfolio choice, Review of Financial Studies 19, 633685.