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2.5 Hypotheses Development
This thesis spotlights on ‘How fund’s attributes influence investor’s buy-and-sell.’ To address this issue, this study presents a series of alternative hypotheses, which are grouped into three parts, including mutual fund fee structures, turnover ratios, and performance returns. The alternative hypotheses are constructed and explained as follow:
The literature on the relation between fund expenses and fund flows exhibits mixed results. Sirri and Tufano (1998) document a negative relation between total fund expenses and fund flows while But Barber and Odean (2000) examines the impacts of various operating fees on mutual fund flows and finds no relation between the two. For one explanation, Khorana and Servaes (2004) propose the mutual fund’s fee is a result of the mark-up, added to its marginal cost by the fund. Taking mutual fund returns into consideration, Goetzmann (1995) find that high expenses cannot explain those poor performing funds. Dowen and Mann (2004) find no relation between expense ratios and returns for equity funds. However, from investor’s perspective, we support the results from Malkiel (1995), who concludes that purchasing low expense funds is better for fund investors; we also believe that fund fees as the costs would drag fund performance, which echoes Carhart (1997)’s paper showing that fund fees have a significant impact on fund performance. Therefore, we argue that if total fee is too high, investor’s buy will be retreating while sell will be accelerating.
In details, funds trade through brokers and brokerage commission applies per trade—purchases or sales. Ideally no matter whether it is fund inflow or outflow, fund
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managers need to adjust its portfolios based on the new subscription and redemption coming into the funds and thereafter brokerage firms execute trades by the instructions. Thus, we expect this variable, or brokerage commission, to be positive.
This is in line with the so-called hidden costs (Prior, 2010; Gao and Livingston 2013).
Transaction fee includes all taxes and related costs, which may be due on the assets and the income of the fund. Especially, transactions in less liquid markets (e.g.
emerging markets or frontier markets) will incur greater costs than those in more liquid markets. From buyer’s view, transaction fee could deter the investor’s subscription if it is too costly but for sellers, it may just be the costs if it’s decided to sell the assets. Another guess is we wonder investors would be more interested in those familiar markets and transaction fee reflects the truth of the higher costs when funds enter in those unfamiliar markets. Under such circumstances, we would expect transaction fee to be negative for investor’s buy but positive for investor’s sell. For management fee, Chevalier and Ellison (1997) conclude that if the fund performance is high, total fee revenue increases as fund grows. Deli (2002) offers the consistent argument that fees are set to provide proper performance incentives for fund managers.
However, we view this much links to the management fee because a fund with a high management fee might take a more aggressive investment approach to gain the returns so as to satisfy mutual fund investors. We therefore expect management fee to be positive for investor’s buy and sell. The custodian’s business is the provision of custodial and trustee services for collective investment schemes and fund portfolios.
From investor’s angle, we would not expect it have effects on investor’s buy and sell.
Based on these reasoning, the mixed set of hypotheses we test for the fee structure on the investor’s buy and sell as follow:
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H1-1.1: Mutual fund’s fees – Brokerage Commission –are positive to investor’s Buy
H1-1.2: Mutual fund’s fees –Brokerage Commission –are positive to investor’s Sell
H1-2.1: Mutual fund’s fees – Transaction Fee –are negative to investor’s Buy
H1-2.2: Mutual fund’s fees –Transaction Fee –are positive to investor’s Sell
H1-3.1: Mutual fund’s fees – Management Fee –are positive to investor’s Buy
H1-3.2: Mutual fund’s fees –Management Fee –are negative to investor’s Sell
H1-4.1: Mutual fund’s fees – Custodian Fee –are neutral to investor’s Buy
H1-4.2: Mutual fund’s fees –Custodian Fee –are neutral to investor’s Sell
Ippolito’s (1989) and Droms and Walker (2001) document no persistence for the turnover rates of mutual funds. Peterson et al. (2001) and Peterson and Riepe (2007) conclude that turnover rates have little to do with mutual fund performance.
Based on the claims, it hints the fund portfolio turnover generates alpha besides the incurring costs. It also hints that turnover by skilled managers is a plus while turnover by unskilled managers is a minus. From our view, although higher alpha funds are able to offset some negative effects from turnover, it is not costless. Turnover of the assets incurs costs in order to trade on information or to meet certain investment criteria like hedging ratios or derivatives limits. Besides, fund sizes of Taiwan equity domiciled funds are not as big as those of offshore funds; it means a big subscription or redemption will need a fund manager to adjust its portfolio timely. Therefore, purchase turnover and sell turnover may increase with incurring costs but generating alpha uncertainly and arguably. However, there is no direct evidence on our thoughts in Taiwan domiciled equity fund market. Therefore, contrary to the previous studies, we hypothesize and test a negative relation between fund turnover ratios and investor’s buy and sell.
H2-1: Turnover rates of mutual funds have negative effects on investor’s Buy H2-2: Turnover rates of mutual funds have negative effects on investor’s Sell
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Hendricks, Patel, and Zeckhauser (1993), and Goetzmann and Ibbotson (1994) document strong evidence that the past mutual fund performance predicts future performance. Some papers support the evidence of the positive correlation between the past fund performance and the signal about the future information, and even the fund flows (Patel et al., 1994; Warther, 1995; Elton, Gruber, and Blake, 1996;
Chevalier and Ellison, 1997; Goetzmann and Peles, 1997; Sirri and Tufano, 1998;
Wermers, 2000). Consistent with the study, we hypothesize that the historical fund performance could stimulate fund flows, from investor’s viewpoints. If a fund persists in a higher performance return, it would stimulate the greater buy-and-sell for mutual fund investors to chase profit-taking. Thus, we expect this variable to be positive. That is, fund flows of investor’s buy-and-sell are positive related to underlying fund performance.
H3-1: Past performance stimulates investor’s Buy H3-2: Past performance stimulates investor’s Sell
Therefore the hypotheses 1 to 3 are formulated to test whether or not the factors identified from previous findings actually influence investor’s subscription and/or redemption. These factors include “expense ratios and its breakdown, including brokerage commission, transaction fee, management fee, and custodian fee,”
“turnover,” and “fund performance.”
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