|Title:||The impact of the use of derivatives on the return and risk of mutual funds : an empirical study on Hong Kong mutual funds industry|
|Subject:||Hong Kong Polytechnic University -- Dissertations|
Mutual funds -- China -- Hong Kong -- Risk assessment
Derivative securities -- China -- Hong Kong
|Department:||Graduate School of Business|
|Pages:||xiv, 119 leaves : ill. ; 30 cm|
|Abstract:||This thesis presents a pioneer study of the effects of derivative use by mutual funds under a control environment in Hong Kong, an international financial center with a managed exchange rate regime and explicit guidelines on mutual funds investment. Using a data set of Hong Kong Mandatory Provident Fund (MPF) scheme funds between January 2001 and December 2003, the results show that fund managers made use of derivatives to fulfill the requirement of limiting the exposure of asset allocation. Moreover, the use of derivatives lowered risk exposure by outperforming and beating the market benchmark when an external financial shock was experienced. This is an extension of the current findings on US and Canadian mutual funds under free-float exchange rate regimes and different regulatory structures. In Hong Kong, the guidelines of the Mandatory Provident Fund Authority (MPFA) allow constituent funds to use derivatives for hedging, but based on the Modigliani and Miller (1958) theorem a firm's value will not vary with strategic hedging. This provided motivation to explore the effect of the use of derivatives on the return and risk of funds in order to provide further suggestions on regulatory improvement for regulators, fund mangers and general provident fund beneficiaries. The empirical evidence obtained in this study suggests that approximately half of the funds use derivatives; with lifestyle funds and equity funds being the most frequent users of foreign exchange forward contracts and option embedded instruments such as equity-linked notes. Although the average level of utilisation as a percentage of net asset value was very low at only 0.8% in 2001, there was a jump to 4.8% in 2002. The results also show that fund managers followed the requirement of holding 30% or more of their assets in Hong Kong dollars, and hedged international assets exposure that are denominated in foreign currencies back into the local currency using foreign exchange forward contracts. There is no systematic difference between the returns of funds that used derivatives and those that did not. However, derivative users faced significantly lower risk as measured by standard deviation than did non-users. There is no evidence that the returns of heavy users differed from those of light users, but the risk of heavy users is significantly lower than that of light users. Moreover, when external shocks in the market place are controlled for, the results suggest that there is a significant increase in the usage level of derivatives after the events, with users enjoying a higher return but lower systematic risk than non-users. To ascertain whether there is pattern of fund structures in the use of derivatives, regression analysis observes that the larger the net asset value, the less likely that fund managers are to use derivatives. Moreover, funds from large fund families and low expense ratio used more derivatives. While the decision to use derivative also depends on the different types of funds, where equity, bond and lifestyle funds are more likely to use derivatives. Finally, whether the agency problem leads to use of derivatives by fund managers to manipulate unexpected risk and performance is explored. However, there is no supporting evidence to conclude that past performance affects the change in risk of MPF funds, and neither is there evidence to support the hypothesis that the use of derivatives moderates current performance against change in risk of the funds. The MPF scheme is still very young, which allows a large spectrum of further study on the issue. After the MPFA introduces its new fund disclosure requirement, the current findings will he able to be extended. The empirical observations in this study were limited by the availability of resources, and future enrichment can be assured if the analysis can be confirmed in different circumstances and a different environment.|
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