Market Timing Analysis

Bulletin of the Transilvania University of Braşov • Vol. 2 (51) - 2009 Series V: Economic Sciences

EVALUATING THE SELECTION AND TIMING ABILITIES OF A MUTUAL FUND

L. DUGULEANĂ 1 I. DUMITRACHE 1 A. GRIMM 1 S. FISCHER 1

Abstract: The paper presents the methodology and a case study to evaluate

the performance of a mutual fund by taking a look at the timing and selection abilities of a portfolio manager. Separating the timing and selection abilities of the fund manager is taken into consideration by two major models. The data about the mutual fund chosen for study is the German blue chip fund “DWS Deutsche Aktien Typ O”, which includes most of the DAX 30 companies. The data consists of 117 monthly observations of the fund returns from January 1999 to September 2008. We used EViews to analyse the data.

Key words: selection ability, timing ability, portfolio risk, regression

analysis.

1. Methodology The literature discusses three major models to evaluate timing and selection abilities. At first we considered taking a look at the overall performance of the fund manager. Therefore we decided to use Jensen’s Alpha (1968) model: Rpt – Rft = αJ + β*(Rmt – Rft) + upt Although Jensen assumes stationarity in systematic risk, which is not the case in an actively managed fund over a long period of time, we used it to provide an image of the overall performance. In a next step we wanted to separate the timing and the selection abilities of the fund manager by taking into consideration two major models: Treynor and Mazuy (1966) and Henriksson and Merton (1981). As a result of several empirical studies about the reliability of the Treynor and Mazuy (1966) model that showed that its beta estimates are biased (see e.g. Grinblatt and Titman (1991)), we decided not to use this model in our analysis. Hence, we

1

decided to choose the model of Henriksson and Merton (1981): Rpt – Rft = αT + βu*Xut + βd*Xdt + upt where Xut = max [0, Rmt – Rft]; Xdt = min [0, Rmt – Rft ]; and...