Asian Journal of Economics and Empirical Research ISSN: 2409-2622 Vol. 1, No. 1, 1-5, 2014 http://asianonlinejournals.com/index.php/AJEER 1 Fama-French Three Factors Model in Indian Mutual Fund Market N. S. Santhi Department of Business Administration KSR College of Engineering Tiruchengode K. Balanaga Gurunathan Department of Finance, Alliance University, Chikkahadade Cross, Chandapura, Bangalore Abstract This work is licensed under a Creative Commons Attribution 3.0 License Asian Online Journal Publishing Group 1. Introduction Mutual funds are the best vehicle for investors, looking for ways to put their savings into stock market (Ajit Dayal, 2011). Tax Saving Mutual Fund Schemes were established with the objective of inviting Indian Tax assessees into the stock market-oriented investment. All Tax Saving Mutual Fund Schemes have same the objective but each scheme differs in returns produced and risks involved. Tax saving mutual fund is one avenue which offers an investor the opportunity to avail tax exemption on investment along with market-related return with the diversified risks. As such, analyses have been made in this paper to measure the performance of Indian Mutual funds market by using Fama French three factor model. In particular 32 growth-oriented open-ended Tax Saving Mutual Fund Schemes have been analyzed in this paper. Table 1 shows various growth-oriented open and closed-ended schemes. From the table, it is also noted that the number of schemes increased after the year 2005. SBI Magnum was the first Tax saving mutual fund scheme launched in the 1993. Since, Union KBC Tax Saver Scheme was launched during November 2011, it has not been considered for the present study. 2. Studies Already Conducted Fama and French (1993), identified five common risk factors in the returns on stock and bonds. Among the five, three factors are related to stock market namely, overall market, firm size and book-to-market equity. The other two factors related to bond-market are maturity and default risks. Stock returns are linked to both stock market factors and bond market returns. Pablo Rogers and Jose Roberto Securoto (2007) have made an analysis on portfolios, in accordance with the Fama and French (1993). They applied two sub-samples of stocks with available data in the Sao Paulo Stock Exchange (BOVESPA). They concluded that the results support the Fama and French Three-Factor model to explain future returns. Tax Saving Mutual Fund Schemes were established with the objective of inviting Indian Tax assessees into the stock market-oriented investment. Tax saving mutual fund is an avenue which offers an investor the opportunity to avail tax exemption on investment along with diversified risk and market-related return. All Tax Saving Mutual Fund Schemes have same the objective but each scheme differs in returns produced and risks involved. The mutual fund performance is based on the performance of market and there is no assurance on return of mutual fund investments. As such, an analysis have been made in this paper to measure the performance of Indian Mutual funds market by using Fama French three factor model. In particular, 32 growth-oriented open-ended Tax Saving Mutual Fund Schemes have been taken for the study. The performance of the TSMF has been compared with the market benchmark S&P CNX Nifty. It is found that there is a difference between expected return and actual return of mutual funds. It is also found that there are certain mutual fund schemes have underperformed than the market benchmark. Not all the mutual fund schemes are safe and secured. It is the responsibility of the investors to find the better performing funds. Keywords: Mutual Funds, Tax saving, growth oriented, open-ended, India, Fama French Three Factor Model. http://creativecommons.org/licenses/by/3.0/ Asian Journal of Economics and Empirical Research, 2014, 1(1):1-5 2 Jan Bartholdy and Paula Peare (2002) compared the performance of stock returns using CAPM and Fama French Three Factor Model. They estimated individual stock returns based on CAPM using different time frames, data frequencies, and indexes. They obtained individual stock returns based on the Fama and French model using five years of monthly data. Joseph Chen et al. (2004), analyzed U.S diversified mutual funds for the period of 37 years from 1962 to 1999 by using monthly returns. The author used Standard Deviation, Capital Asset Pricing Model of William F. Sharpe, Eugene F. Fama and Keneeth R. French three-factor model for the analysis. One month Treasury bill return was considered by the author for risk free rate of return. It has been found that these funds’ family size does not significantly erode the performance of this fund. Bhavna (2006) studied the Fama and French three-factor model of stock returns along with its variants, including Capital Asset Pricing Model for 79 stocks listed on the BSE-100 stock market index and found that factor portfolios that explain the returns are the market factor, size factor (SMB) and value factor (HML). The author concluded that the Fama and French fairs better in explaining the cross-section of returns in the portfolios than its variants and the CAPM. Yash Pal (2010) analyzed 187 companies by using CAPM and the Fama French for the period of five years from June 2004 to June 2009. The study concluded that efficiency of Fama French Model, for being a good predictor, cannot be ignored in India but either of the two factors (size and value) might improve the model. Vanita Tripathi (2008) examined the relationship between four company fundamental variables (viz. market capitalization, book equity to market equity ratio, price earnings ratio and debt equity ratio) and equity returns in Indian stock market using monthly price data of a sample of 455 companies forming part of S&P CNX 500 Index over the period June 1997 to June 2007. Table-1. Open-Ended Tax Saving Mutual Fund Schemes - Growth S. No Open-Ended Schemes (as on March 2011) Date of Inception 1. SBI Magnum Tax gain Scheme 24-February-1993 2. CanaraRobeco Equity Tax saver 25- February -1993 3. HDFC TaxSaver 18-December-1995 4. LICMF Tax plan 11-January-1997 5. Sahara Tax Gain 31- December -1997 6. Franklin India Tax shield 10-April-1999 7. ICICI Prudential Tax Plan 09-August-1999 8. UTI - ETSP 15-November-1999 9. Escorts Tax Plan 01- April -2000 10. HDFC Long Term Advantage Fund 26- December -2000 11. ING Tax Savings Fund 12- February -2004 12. Sundaram Tax Saver OE 04-May-2005 13. Reliance Tax Saver (ELSS) Fund 25-July-2005 14. L&T Tax Saver Fund 27-September-2005 15. Kotak Tax Saver-Scheme 29- September -2005 16. BNP Paribas Tax Advantage Plan (ELSS) 07- November -2005 17. Fidelity Tax Advantage Fund 05- January -2006 18. DWS Tax Saving Fund 24- January -2006 19. Birla Sun Life Tax Plan 03-October-2006 20. HSBC Tax Saver Equity Fund 20- November -2006 21. Religare Tax Plan 20- November -2006 22. DSP Black Rock Tax Saver Fund 27- November -2006 23. Taurus Tax Shield 05-March-2007 24. JM Tax Gain Fund 24- December -2007 25. Bharti AXA Tax Advantage Fund-ECO Plan 12- February -2008 26. Bharti AXA Tax Advantage Fund-Regular Plan 12- February -2008 27. Birla Sun Life Relief 96 03-June-2008 28. IDFC Tax Advantage (ELSS) Fund 01- December -2008 29. Quantum Tax Saving Fund 10- December -2008 30. JPMorgan India Tax Advantage Fund 18- December -2008 31. Edelweiss ELSS Fund 26- December -2008 32. Axis Tax Saver Fund 17- December -2009 Source: (www.amfiindia.com) 3. Tools Applied to Measure Risk and Return The aim of this study is to examine the performance of Tax Saving Mutual Fund Schemes. Daily NAV is used for computing annual returns of Tax Saving Mutual Fund Schemes (John Sorros, 2003). Mean returns are calculated by averaging the monthly returns over the relevant time period. Fama-French three factor model is used analysis the performance of TSMF. Fama–French three-factor model is designed by Eugene Fama and Kenneth French to describe stock returns. This model uses three variables namely market, size and stocks with a high book-to-market ratio (BtM, customarily called value stocks, contrasted with growth stocks). r = Rf + β3 (Km – Rf) +bs . SMB + bv. HML + α Asian Journal of Economics and Empirical Research, 2014, 1(1):1-5 3 Where, r = Portfolio's expected rate of return Rf = Risk-free return rate Km = Return of the whole stock market SMB = Small [market capitalization] Minus Big HML = High [book-to-market ratio] Minus Low 4. Fama-French Three Factor Model The traditional asset pricing model Capital Asset Pricing Model (CAPM) uses only Beta to describe the returns of a portfolio with market returns. Whereas, the Fama–French model uses three variables such as market, size of the portfolio and value of the portfolio. This model used SMB for “small (market capitalization) minus big” and HML for “high (book-to-market ratio) minus low”. It measures the excess returns of small caps over big caps and value stocks over growth stocks. The assets of all the 31 schemes as on March 2012 have been considered for the study. SMB is the difference between the average return of smallest 30% of Tax Saving Mutual Fund Schemes and the average return of the largest 30% of the schemes assets (Kent Womack and Ying Zhang, 2003). A positive SMB indicates that small cap stocks outperformed large cap and a negative SMB indicates the large caps outperformed in a particular period. The five schemes with least assets are Bharti AXA Tax Advantage Fund-ECO Plan, Escorts Tax Plan, JPMorgan India Tax Advantage Fund, Quantum Tax Saving Fund and Edelweiss ELSS Fund which is having less than 10 crore assets. The schemes with greatest assets are ICICI Prudential Tax Plan, Sundaram Tax saver OE- App, Reliance Tax Saver (ELSS) Fund, HDFC TaxSaver and SBI Magnum Tax gain Scheme 1993 which is having more than 1000 crores. Table 2 shows the assets of the schemes. Table-2. Assets of the Tax Saving Mutual Fund Schemes S. No Tax Saving Mutual Fund Schemes Asset (cr) 1. Bharti AXA Tax Advantage Fund-ECO Plan 3.1 2. Escorts Tax Plan 3.8 3. JPMorgan India Tax Advantage Fund 4.2 4. Quantum Tax Saving Fund 5.5 5. EDELWEISS ELSS FUND 5.9 6. SaharaTax Gain 11.1 7. L&T Tax Saver Fund 27.8 8. ING Tax Savings Fund 29.5 9. Bharti AXA Tax Advantage Fund 32.5 10. LIC MF Tax plan 34.2 11. JM Tax Gain Fund 40.8 12. Birla Sun Life Tax Plan 45.2 13. DWS Tax Saving Fund 58.7 14. Taurus Tax Shield 72.8 15. Religare Tax Plan 111.5 16. BNP Paribas Tax Advantage Plan 118.6 17. IDFC Tax Advantage (ELSS) Fund 134.9 18. HSBC Tax Saver Equity Fund 196.2 19. CanaraRobeco Equity Tax saver 362.4 20. Kotak Tax Saver-Scheme 433.1 21. UTI – ETSP 461.6 22. DSP Black Rock Tax Saver Fund 724.4 23. Birla Sun Life Relief 96 765.9 24. Franklin India Tax shield 812.4 25. HDFC Long Term Advantage Fund 840.5 26. Fidelity Tax Advantage Fund 1,167.10 27. ICICI Prudential Tax Plan 1,278.40 28. Sundaram Tax saver OE- App 1,391.30 29. Reliance Tax Saver (ELSS) Fund 1,972.80 30. HDFC TaxSaver 3,114.10 31. SBI Magnum Tax gain Scheme 1993 4,778.50 Source: Secondary Data HML has been constructed to measure value premium with high book to market values. HML is the difference between the average return of the 50% of the schemes with the highest book to equity and the 50% of the schemes with the lowest book to equity of the schemes (Kent Womack and Ying Zhang, 2003). A positive HML indicated value scheme outperformed in a particular period and a negative HML indicates growth schemes outperformed in a month. Table 3 shows the book to market ratio of the Tax Saving Mutual Fund Schemes. The five schemes with least Book to Market Ratio are SBI Magnum Tax gain Scheme 1993, HDFC Long Term Advantage Fund, ICICI Prudential Tax Plan, Franklin India Tax shield and HDFC TaxSaver. The schemes with high book to market ratio are Asian Journal of Economics and Empirical Research, 2014, 1(1):1-5 4 JM Tax Gain Fund, Birla Sun Life Relief 96, DWS Tax Saving Fund, Birla Sun Life Tax Plan and HSBC Tax Saver Equity Fund. Table-3. Book to Market of Tax Saving Mutual Fund Schemes Tax saving mutual fund schemes Book to Market JM Tax Gain Fund 1.5916 Birla Sun Life Relief 96 0.9930 DWS Tax Saving Fund 0.8390 Birla Sun Life Tax Plan 0.7669 HSBC Tax Saver Equity Fund 0.7170 L&T Tax Saver Fund 0.7072 BNP Paribas Tax Advantage 0.6926 DSP Black Rock Tax Saver Fund 0.6324 Religare Tax Plan 0.5794 Kotak Tax Saver-Scheme 0.5775 JPMorgan India Tax Advantage fund 0.5724 IDFC Tax Advantage (ELSS) Fund 0.5353 Edelweiss ELSS Fund 0.5227 Bharti AXA Tax Advantage Fund 0.4812 Bharti AXA Tax Advantage Fund-ECO Plan 0.4778 Fidelity Tax Advantage Fund 0.4747 Reliance Tax Saver (ELSS) Fund 0.4695 Quantum Tax Saving Fund 0.4538 CanaraRobeco Equity Tax saver 0.3852 LIC MF Tax plan 0.3702 ING Tax Savings Fund 0.3627 Taurus Tax Shield 0.3058 Sahara Tax Gain 0.2743 UTI – ETSP 0.2661 Escorts Tax Plan 0.2642 Sundaram Tax saver OE- App 0.2384 SBI Magnum Tax gain Scheme 1993 0.1714 HDFC Long Term Advantage Fund 0.0747 ICICI Prudential Tax Plan 0.0736 Franklin India Tax shield 0.0468 HDFC TaxSaver 0.0448 Source: Secondary Data Table 4 summarizes the results of Fama French three factor analysis. The tables shows the coefficients of Rm- Rf, SMB and HML that is obtained by regressing Ri-Rf with Rm-Rf, SMB and HML. These coefficients are substituted in Fama French three factor model to obtain the Expected Rate of Return. Additionally, Actual Rate of Return of these schemes have been calculated by using the historical values of past three years from 2009-10 to 2011-12. Table 4 shows that Reliance Tax Saver (ELSS) Fund, CanaraRobeco Equity Tax saver, Religare Invesco Tax Plan, SaharaTax Gain and Bharti AXA Tax Advantage Fund-ECO Plan performed well with high difference in expectation and actual return. Sundaram Tax saver OE- App, Kotak Tax Saver-Scheme, DWS Tax Saving Fund, Franklin India Tax shield and L&T Tax Saver Fund-Cumulative were not performed well. The actual return of these schemes was lower than the expected return. 5. Conclusion Performance of Tax Saving Mutual Fund Schemes were analyzed by using Fama French. The performance of the TSMF has been compared with the market benchmark S&P CNX Nifty. There will be a difference between expected return and actual return of mutual funds. The minimum difference between actual and expected return on funds show a stable performance in the market. There are certain funds where the minimum returns are expected by the investors but the funds might give a higher return and there are certain funds where the maximum returns are expected by the investors but those funds might give a lower return. It is found that there are certain schemes which have been underperformed than the market benchmark. There are certain funds that outperform the market benchmark. It is found that, Reliance Tax Saver (ELSS) Fund, Canara Robeco Equity Tax saver, Religare Invesco Tax Plan, Sahara Tax Gain and Bharti AXA Tax Advantage Fund-ECO Plan have performed well with high difference in expectation and actual return. From the analysis, it can be concluded that there has to be some other factors other than the factors considered by Fama French model that would explain the performance of variation among the Indian tax saving mutual fund market. Table-4. Coefficients, Expected Return and Actual Rate of Return of the Tax Saving Mutual Fund Schemes S. No Tax Saving Mutual Fund Schemes Coefficient Expected Return Actual Return Difference RM-RF SMB HML 1 Reliance Tax Saver (ELSS) Fund 0.7517 -0.4336 1.2158 0.1342 1.9581 1.8240 Continue Asian Journal of Economics and Empirical Research, 2014, 1(1):1-5 5 2 CanaraRobeco Equity Tax saver 0.8306 -0.2054 0.3408 0.3615 1.3303 0.9688 3 Religare Tax Plan 0.6067 -0.3036 0.8697 0.1476 1.1113 0.9637 4 Sahara Tax Gain-Growth 0.8473 -0.0524 0.9628 0.1849 1.1274 0.9425 5 Bharti AXA Tax Advantage Fund-ECO Plan 0.9886 0.2817 1.4450 0.0695 0.9150 0.8456 6 Bharti AXA Tax Advantage Fund 0.9914 0.2838 1.4270 0.0749 0.9028 0.8279 7 Quantum Tax Saving Fund 0.7430 0.4863 -0.0847 0.3398 1.1484 0.8086 8 Birla Sun Life Relief 96 0.9323 -0.3519 0.8731 0.2845 1.0911 0.8066 9 ING Tax Savings Fund 0.8720 0.1051 0.4753 0.2996 1.0819 0.7823 10 HDFC TaxSaver 0.8094 -0.2273 -0.1059 0.4722 1.2322 0.7600 11 Fidelity Tax Advantage Fund 0.7594 0.0826 0.1812 0.3339 1.0646 0.7307 12 SBI Magnum Tax gain Scheme 1993 0.8256 -1.0357 0.8475 0.3442 1.0743 0.7301 13 BNP Paribas Tax Advantage Plan 0.6877 -0.3951 0.9244 0.1788 0.8860 0.7072 14 Taurus Tax Shield 0.9297 0.5048 0.8527 0.1685 0.8719 0.7034 15 HDFC Long Term Advantage Fund 0.8248 0.0310 -0.3155 0.4966 1.1849 0.6883 16 IDFC Tax Advantage (ELSS) Fund 0.7319 -0.1575 1.2269 0.0845 0.7571 0.6726 17 Edelweiss ELSS Fund 0.6976 -0.4201 1.3587 0.0733 0.7367 0.6634 18 Birla Sun Life Tax Plan 0.7991 -0.4789 1.2689 0.1458 0.7698 0.6240 19 HSBC Tax Saver Equity Fund 0.7725 -0.1209 0.7870 0.2102 0.8338 0.6236 20 DSP Black Rock Tax Saver Fund 0.8269 -0.0431 0.2150 0.3699 0.9531 0.5831 21 JM Tax Gain Fund 0.8106 -0.1832 1.6051 0.0214 0.5077 0.4863 22 JPMorgan India Tax Advantage Fund 0.7487 1.1519 0.0204 0.2213 0.7066 0.4854 23 UTI – ETSP 0.7642 0.0118 0.4400 0.2784 0.7116 0.4331 24 LIC MF Tax plan 0.8821 -0.1357 0.6201 0.2997 0.5659 0.2661 25 Escorts Tax Plan 0.9388 1.3115 0.4344 0.1677 0.4120 0.2443 26 ICICI Prudential Tax Plan 0.8569 0.0149 0.1210 0.3983 0.4720 0.0738 27 Sundaram Tax saver OE- App 0.8731 -0.5069 1.0954 0.2246 0.2360 0.0113 28 Kotak Tax Saver-Scheme 0.8961 0.1592 0.7727 0.2243 0.0463 -0.1780 29 DWS Tax Saving Fund 0.7232 -0.2497 1.1125 0.1237 -0.1377 -0.2615 30 Franklin India Tax shield 0.7210 -0.1676 0.0995 0.3748 0.1093 -0.2655 31 L&T Tax Saver Fund 0.9494 -0.2921 0.5659 0.3629 -0.0883 -0.4512 Source: Secondary Data Note: Fama French model was employed with 31 open ended schemes for the three years (2009-11 to 2001-12) as the required data is available only for that period. 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