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explained later. The macro data is collected from Central Bank of the Republic of China (Taiwan), including 4 variables and using month-end data on a monthly basis from January 2010 to December 2014: Monetary Aggregate M1B (yoy), CPI Change Rate (yoy), 31- 90 Day Commercial Paper Interest Rate, and Taiwan 10-Year Bond Yield.
3.2 Definition and Explanation of Variables
3.2.1 Fee Description
Brokerage Commissions and Transaction Fees
Brokerage commissions go toward paying brokerage firms commissions for executing trades. After a brokerage trade has been executed, the securities broker may collect a processing fee from the funds. Transaction fee goes toward paying taxes related incurred from dealing with purchases and sales of underlying assets from a mutual fund.
Management Fees
John (2004) defines the management fees by far the largest component of mutual fund expenses, which represent investment advisory charges for portfolio management, but may also confusingly include other administrative expenses as well.
Khorana, Servaes, Tufano (2009) point that management fees represent the charges levied each year by funds for management services, which always cover investment management services, while some even include payments for administration and distribution.
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Custodian Fees
According to the Regulations Governing Securities Investment Trust Funds, amended on September 25, 2009, Article 16 says the custodian institution shall establish and maintain separate accounts for the securities investment trust funds under its custody. Custodian is obligated to safeguard the assets of the fund and it is acting pursuant to specific proper instructions and providing custodial and trustee services. Charles and Dennis (2005) in the paper titled 'An Analysis of Mutual Fund Custodial Fees' mention that the custodial fee is usually subject to arms-length negotiation with third parties, and is typically paid directly from fund assets, which is different from distribution fees paid to a related party. In the above paper it shows the evidence that the expense ratio (excluding custodial fees) is negatively associated with custodial fees. One possible reason for this result is that firms exposed to higher non-custodial expenses might pressure the custodians to provide services at a lower price to avoid having their expense ratios become unavoidable high.
Turnover Ratio
Based on the definition of Morningstar, turnover ratio measures a fund's trading activity, which is computed by taking the lesser of buying or selling (excluding all securities with maturities of less than one year) and dividing by average monthly net assets. The ratio means a mutual fund holdings that have been turned over, changed, or replaced with other holdings in a given time period. It tells you the roughly idea of the fund’s strategy like a buy-and-hold strategy or it experiences considerable purchases and sales of its holdings. Because every fund's trading activity involves a commission, this means that high turnover ratios often incur high expense ratios.
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Lavin and Magner (2014) posit three dimensions determining the turnover of a mutual fund. They are efficiency, agency problems, and behavioral biases. For efficiency, because of economies of scale and scope, financial intermediaries are able to reduce its transaction costs by diversifying their portfolios, preserving added liquidity, and even monitoring the underlying investments. In the same way, Hellwig (1991) suggests that mutual fund products can be seen as coalitions of investors who exploit economies of scale and scope in transaction technologies. As for agency problems, the incentives for fund managers can induce them to execute an excessive number of trading but excessive transaction costs will reduce shareholders’ return on mutual fund investments. Lastly, for behavioral biases, or overconfidence, it arises because of fund managers’ overestimation of their ability and judgement for the underlying stocks and therefore they overreact to buying and selling of financial assets (Daniel, Hirshleifer, and Subrahmanyam, 1998). The mentioned three dimensions explain why the turnover rates are high for some mutual funds.
Past Fund Performance (one year)
In the thesis, we use one year fund performance calculated by the Morningstar's Total Return. As defined by the Morningstar Investing Glossary2, Morningstar's calculation of total return, expressed in percentage terms, is determined by taking the change in price, reinvesting, if applicable, all income and capital gains distributions during the period, and dividing by the starting price. For the calculation, it doesn't take sales charges (such as front-end loads, contingent deferred sales charge, or redemption fees) into consideration.
2 Definition of 'Total Return' by Morningstar Investing Glossary http://www.morningstar.com/InvGlossary/total-return.aspx
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3.2.2 Control variables
In our regression analysis, we add five macro-economic factors as the control variables to further explain additional information if any independent causal effects on the dependent variables. They are Monetary Aggregate M1B (yoy), CPI Change Rate (yoy), 31- 90 Day Commercial Paper Interest Rate, and Taiwan 10-Year Bond Yield, respectively. Why we choose these control variables lies in the two reasons. First, these macro-economic variables are highly related to the business cycle in Taiwan.
Second, some macro-economic factors reflect the opportunity costs, or the value forgone in order to buy or sell the mutual funds. By doing so, the results may be prevented from the misleading or biased estimation. The definition below is from the Central Bank of the Republic of China (Taiwan)3and Bloomberg websites.
Monetary Aggregate M1B (yoy)
M1B = M1A + Passbook savings deposits of Individuals and non-profit organizations in banks and community financial institutions. (So far, only individuals and non-profit organizations are allowed to open Passbook Saving accounts).
CPI Change Rate (yoy)
According to the definition from the World Bank, Consumer Price Index reflects changes in the cost to the average consumer of acquiring a basket of goods and services that may be fixed or changed at specified intervals, such as yearly.
Consumer Price Index CPI in Taiwan is reported by the Directorate-General of Budget, Accounting and Statistics, Taiwan
3 The definition is from ‘Definitions of Key Financial Terms’ on the website of the Central Bank of the Republic of China (Taiwan).
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31- 90 Day Commercial Paper Interest Rate
Commercial papers can be divided into type I (CPI) and type II (CPII). The CP1 is derived from an actual transaction while the CP2 is issued by legally registered private corporations or public enterprises for the purpose of fund raising.