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The effectiveness of capital management strategies used by the investment funds in
Poland
Paweł Trippner, University of Social Sciences, Faculty of Management, Department of
Finance. ptrippner@spoleczna.pl
Introduction
Financial intermediaries play an extremely important role in the financial system of
the state. They operate in the financial market as institutions that enable households and
businesses to convert savings into investments. Investment funds are the most conventional
institutions which are dealing with financial intermediation.
The goals of the paper are to characterise the essence of investment funds operation in
the role of financial intermediaries, to describe the investment strategies and to characterise
the methodology for measuring the effectiveness of management of the capital entrusted by
the clients.
The paper formulates a research hypothesis, according to which, the strategies of
capital investment used by the investment funds have an impact on the level of their
performance, while funds holding higher risk portfolios perform better compared to the funds
using safer investment strategies.
The analysis will be covered by the most popular investment funds in Poland: Polish
Equity Funds, Polish Bond Funds, Polish Mixed Balanced Funds, Money Market Funds and
Polish Mixed Growth Stable Funds. The analysis will be carried out for the period 2009 –
2012.
1. The nature and importance of financial intermediaries in the financial system
A special role in the transformation of savings into investment plays the financial
market, in which the matching of supply and demand for financial resources takes place.
Supply side of the financial market is represented by actors with financial surpluses that are
named as capital donors or investors. The financial market enables them to multiply the
money they have. These entities are mainly households and businesses [Nacewski J.,
Zabielski K., 2000, pp. 15 - 16].
Demand side of the financial markets is represented by entities seeking capital in order
to meet their lending or investment needs. Own financial resources of these entities are not
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sufficient, and therefore they demand additional financial resources. These entities are
referred to as capital takers or issuers, and these are mostly companies and state treasury
[Wypych, M., 2000, p. 114].
The functions of financial intermediaries, that use mainly external capital, can be
described as [Dobosiewicz Z., 2009, pp. 44 - 45]:
• intermediation between the owners of surplus funds and those demonstrating a need for
cash,
• moving the time of consumption,
• concentrating capital and the transformation of money over time,
• reducing the financial risk,
Financial intermediaries, in exchange for their services, are given the right to dispose
of the financial resources for a period of time, which allows them to lend money to other
parties at a specified interest rate, or to invest these funds in securities.
Non-banking financial intermediaries make a simple transformation of savings into
capital in the sense that they have no right to make money on the basis of acquired savings.
They make changes to the structure of financial resources created by the banking
system. The idea of the action boils down to collect financial resources from individual
investors (mainly from households, to a lesser extent from the companies) and then, their
professional placement on the financial market.
Compared to banks, non-banking financial intermediaries offer entities willing to save,
more diverse financial instruments in terms of the risk, resulting in the further differentiation
of yields. It is very important that a wider range of financial deposits supports greater
flexibility of the financial market, which has a major impact on facilitating and streamlining
the process of transformation of savings into capital, followed by a physical investment in the
economy as a whole [Owsiak S., 2002, pp. 227 - 228].
Non-banking financial intermediaries create conditions for investing for those who
prefer a higher income, and are willing to take more risk. This does not mean that their
investment offer does not include financial instruments with the risk of a similar or even
lower level than the risk as for bank deposits [Proniewski M., Niedźwiedzki A., 2002, p. 17].
2. The nature and tasks of investment funds as institutional investors
The first institution that possessed the characteristics of the investment fund was
established by King William I in Brussels in 1822. The members were selected (not all who
wish were able to become members of it), and the purpose of its activities was to create small
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and medium-sized enterprises a possibility to invest capital in foreign debt securities
[Chróścicki A., 1998, p 13]. Common development of this type of financial institutions began
in England and Scotland. The stimulus was a fast-growing economy of the Great Britain, with
a simultaneous rapid enrichment of the population and an increase in the propensity to save.
In the early years of operation, the majority of the funds were the closed funds - they
emit a fixed number of shares adjusting it to market demand. A turning point in the history of
the U.S. investment funds market was when the British funds noticed the potential of the U.S.
financial market. The rates of return achieved on the U.S. market were usually higher than the
rates in Europe. From that moment, fast and rapid growth of investment funds in the United
States has been recorded.
The first two decades of the twentieth century were the period of the real development
of investment funds in the United States and England. Hundreds of such institutions were
established then, including The Massachusetts Trust Fund, created in 1924 [Sas Kulczycka K.
(ed), 1999 p. 4]. The Massachusetts Trust Fund placed the collected assets in shares of 45
companies (diversification of the investment portfolio), and consistently offered the
opportunity to purchase and resale of the shares by investors at a price based on the present
value of the fund's assets. It was, so the first open investments fund [Chróścicki A. 1998, pp.
13 - 14].
The first piece of legislation in Poland, governing the operation of investment funds,
was the Act of 28 August 1997 on investment funds.
In accordance with the contents of the Act, a fund is "a legal person, who’s the only
purpose is solely to invest funds collected in a public offer in securities and other property
rights defined in the Act."1 The fund operates according to the rules of reducing the
investment risk.
From the point of view of funds’ customers, the important regulation is the amendment
introduced in the Act of 23 November 2012 amending the Act on Investment Funds and the
Act on the Supervision of Financial Market. The most important feature of the Act is the
introduction of an obligation to publish information in the form of KIID (Key Investor
Information Document) which will replace the information prospects.
The most important issue is to determine the profit and risk profile of the fund. This
indicator is presented on a numerical scale from 1 to 7, and the methodology of its calculation
is based on the average fluctuations in pricing in annual perspective, that occurred in the past
five years.
1 The Act of 28 August 1997 on investment funds, Journal of Laws of 1997 no. 139, item 933.
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Most individual investors do not meet the above requirements and, therefore, they
entrust their financial resources to specialized financial institutions, including investment
funds. These institutions have advantages not available to individual investors. The most
important are [Dawidowicz, D., 2008, p. 10]:
- Professional management,
- Diversification of the portfolio,
- The liquidity of the investment,
- Security of the deposit,
- Control of the investment,
- The cost of investing,
- The choice of strategy corresponding to the propensity to take risk.
Investment funds can be classified from different points of view. According to the
criteria describing the way the fund investment operates, funds can be divided into
[Dawidowicz, D., 2008, p. 18]:
• open-ended funds,
• closed-ended funds,
• mixed funds.
When asset allocation criteria, is taken into account, investment funds can be divided
into the following types [Dawidowicz, D., 2008, p. 24]:
• equity funds,
• balanced funds,
• stable growth funds
• bond funds,
• money market funds,
• mortgage funds,
• foreign funds,
• universal funds.
3. Methods for measuring the effectiveness of the funds’ investment policy
While reviewing the literature on methodology of assessing the effectiveness of the
investment funds, three American economists, who are among the first called “financial
economists” are usually pointed out as pioneers in this field. Those are W. F. Sharpe, J. L.
Treynor and M. C. Jensen.
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Their contribution to the study on the funds was to develop measures that take into
account an investment risk in assessing the effectiveness of investment funds.
Despite, they use of different measurement, obtained results were similar.
An innovative approach to how to assess the effectiveness of the capital management
by the investment funds is described in the following research papers:
Jensen M. C., The performance of mutual funds in the period 1945 – 1964,
Sharpe W. F., Mutual fund performance,
Treynor J. L., How to rate management of investment funds.
Evaluation of the effectiveness of the investment policy of pension funds and
investment funds should be considered in the context of the functions they perform on the
financial market. Investment funds companies are the entities that manage the funds.
The rate of return is a criterion for assessing the effectiveness of the funds. The rate of
return is measured by changes in the value of participation units, the level of risk involved and
the additional compensation gains.
Assessment of the effectiveness of capital management by investment funds and
pension funds should be carried out in two areas:
the rate of return on investment,
compensation of the risk by the additional rate of return.
The analysis is based on the rate of return defined as the percentage ratio of capital
growth over the analysis period to the amount of capital at the beginning of the period (initial
capital). In order to compare this calculated rate of return to interest yields for the various
instruments of financial market, the rate of return should be calculated for the period covering
a year (annual interest rate) or for long-term periods (eg. three-year rate of return). The
formula to calculate the rate of return on investment in the funds is as follows [Dybał M.,
2008, p 66]:
x100
Wj
WjWj
R
1
12
where:
R – rate of return,
1
Wj
- The value of the participation or clearing unit at the beginning of the period,,
2
Wj
- The value of the participation or clearing unit at the end of the period.
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In order to make a more complete and objective analysis of the effectiveness of
management of capital by collective investors, the use of a simple rate of return is considered
to be insufficient. Therefore, it is advisable to use an additional measure that takes into
account of the level of investment risk and the extent of its compensation by additional
profits.
One such measure is the Information Ratio. It is a measure that identifies the size of
the additional rate of return in comparison with unit risk taken by the fund investment. It is
presented in the following form [Dawidowicz D., 2008, p. 92]:
TE
RR
IR mp
where:
IR – information ratio,
Rp – rate of return of the fund,
Rm – benchmark rate return of the (reference portfolio)
TE - tracking error of the portfolio of the fund in relation to the benchmark (standard
deviation of the difference in the rates of return of the fund and its benchmark).
Information ratio is based on the Sharpe ratio, but is related to the selected benchmark
portfolio – the rate of return on the fund wants to cross, rather than the risk-free rate of return.
It reflects the investor's ability to create a portfolio with a more favourable rate of return than
the return on the model portfolio.
The higher the level of IR, the higher efficiency of management of the fund. The
satisfactory level of IR is value above 50%, and if IR exceeds the value of 75%, this is a very
good result [Kothari S.P., Warner J.B., 2001, p. 2003].
Tracking Error and Information ratio are widely and commonly used in the process of
assessing the effectiveness of the funds’ investment policy because they enable comparing
funds using different investment strategies, with different levels of risk [Kothari S.P., Warner
J.B., 2001, p. 2009].
4. Assessment of the effectiveness of funds’ investment policy in 2009 – 2012
The first part of the analysis concerns the comparison of rates of return for the period
2009 – 2012 for the selected types of investment funds. The calculations were carried out for
investment funds that have been classified, due to the investment strategies used in
accordance with the methodology of the Polish Financial Supervision Authority. It is possible
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to distinguish three main groups of funds. The first group consists of funds that have shares in
their portfolios, apply strategies to secure funds; and funds that invest in financial markets
abroad, where there is an additional factor in the form of foreign exchange risk. Performance
results are presented in the following figure and table.
Table 1. Rates of return on the TFI market in 2009 – 2012
Type of investment fund Rate of return (in %)
Polish equity funds – AP 5.00
Polish mixed balanced funds – ZR 10.70
Polish SMEs equity funds – AMŚP 4.00
Polish mixed stable growth funds – SW 13.50
Polish bond funds – PD 22.40
Money market funds (PLN) – PiG 13.30
Polish mixed active allocation funds – AAL 6.30
Polish universal debt funds – DU 20.50
Polish capital protection funds – OK 11.10
Foreign markets funds – ZAG 6.70
Source: own calculations based on www.analizy.pl
Figure 1. Rates of return on the TFI market in 2009 – 2012
Source: own calculations based on www.analizy.pl
Analysing these data, it should be noted that during the reporting period, the highest
rate of return reached the funds, using safe investment strategies. Bond funds and universal
debt funds were the only that achieved during the three years the rates of return above 20%,
which is significantly higher than the results of other types of funds.
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Stable growth funds achieved lower profit by nearly 9 percentage points than the best
of the funds. Another funds, that hold shares in their investment portfolios, resulted even
worse in comparison with debt funds, respectively: the profit of balanced funds was lower by
nearly 12 percentage points, active allocation funds by almost 16 percentage points, Polish
equity funds generated a rate of return lower by more than 17 percentage points, while
investing in companies in the sector of small and medium-sized enterprises by more than 18
percentage points.
Investing on foreign financial markets also did not brought comparable results with
Polish funds based on secure investment strategies. The results of foreign funds were more
than 15 points worse for the analysed period.
The figure below presents a comparison of rates of return of the Polish secure funds
(bond, universal debt securities, money market funds and capital protection) with returns of
funds using strategies with a higher risk (stable growth, balanced, active allocation, Polish
equities and Polish SMEs equities).
Figure 2. Rates of return – secure vs. aggressive funds in 2009 – 2012
Source: own calculations based on www.analizy.pl
Secure funds recorded, in the analysed period, rate of return higher more than twice as
many funds holding high-risk securities in their portfolios. This is a signal that during the
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period of uncertainty on financial markets, funds using strategies involving the protection of
the capital achieve higher rates of return.
The second part of the analysis concerns the evaluation of the effectiveness of the
funds’ investment policy in the relationship between the achieved rates of return and the level
of risk. The methodology of calculation was presented in the previous section of the paper.
According to the literature, satisfactory level of Information Ratio is at least 50%. The results
below this level mean the lack of adequate compensation for the additional investment risk in
the form of superior returns. Performance results are presented in the following figure.
Figure 3. Information Ratio for selected investment funds
Source: own calculations based on www.notoria.pl and www.analizy.pl
Presented data clearly indicates that the efficiency of the investment funds market in
the period 2009 - 2012 was unsatisfactory. Incurring additional risk is found to be justified, as
the IR indicator exceeds 50%. In this case the efficiency of the investment fund is
significantly higher than the market benchmark.
None of the different types of funds reached the level of 50% for IR, even without
approaching the number. The secure funds had better results – they achieved IR level above,
respectively, 15 and 23 per cent. However, any group of funds with shares in their investment
portfolios did not exceed 13%, which should be assessed negatively.
Summary
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Investment funds are important players on financial markets. They act as
intermediaries in the process of conversion of savings into investments. Investment funds are
institutions of public trust. They play an important role on financial markets, especially on the
capital market and as part of a voluntary pension pillar in Poland.
The goal of the paper defined in the introduction has been achieved. The paper
presented the essence and role of the funds as financial intermediaries; it described principles
of their operation and legal regulations. The methodology for assessing the effectiveness of
investment funds’ management of capital entrusted by their clients was also elaborated.
The research hypothesis formulated in the introduction has been rejected. Use of the
normal rate of return on investment, as well a joint measure of the risk – return relationship
(Information Ratio) could not confirm the higher efficiency of the investment funds, using
aggressive asset management strategies compared to secure types of investment funds.
No group of funds generated profits for their clients, significantly exceeding market
benchmarks. It’s possible to formulate following conclusion, according to which there is a
need of significantly improvement in the efficiency of investment policy applied by
investment funds.
Abstract
Collective investors play an extremely important role in the financial system of the
state and in the economy. They operate in the financial market as institutions that enable
households and businesses to convert savings into investments. Investment funds are the most
conventional institutions which are dealing with financial intermediation.
The main purpose of the submitted paper is to characterise the essence of investment
funds operation in the role as financial intermediaries, to present the investment strategies and
to characterise the methodology for measuring the effectiveness of capital management
entrusted by the clients.
The author has formulated a research hypothesis, according to which, the strategies of
capital location policy used by the investment funds have an impact on the level of their
performance, while funds holding higher risk portfolios perform better compared to the funds
using passive investment strategies.
References:
Literature:
1. Chróścicki A., Fundusze inwestycyjne i emerytalne, ABC, Warszawa, 1998.
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2. Dawidowicz D., Fundusze inwestycyjne, rodzaje, typy, metody pomiaru i ocena
efektywności, CeDeWu, Warszawa 2008,
3. Dobosiewicz Z., Wprowadzenie do finansów i bankowości, PWN, Warszawa 2009,
4. Jensen M. C., The performance of mutual funds in the period 1945 – 1964, Journal of
Finance, 1968, May, vol. 23.
5. Kothari S.P., Warner J.B., The Journal of Finance, Vol. LVI, No 5, 2001.
6. Nacewski J., Zabielski K., Funkcjonowanie rynków finansowych, Wydawnictwo
Naukowe Wyższej Szkoły Kupieckiej, Łódź 2000.
7. Owsiak S., Podstawy nauki finansów, PWE, Warszawa 2002.
8. Proniewski M., Niedźwiedzki A., Rynek pieniężny i kapitałowy. Podstawy teorii i
praktyki, Wyższa Szkoła Finansów i Zarządzania w Białymstoku, Białystok 2002.
9. Sas-Kulczycka K. (red), Instytucje wspólnego inwestowania w Polsce, WIG PRESS,
Warszawa 1999.
10. Sharpe W. F., Mutual fund performance, Journal of Business, 1966, No. 1.
11. Szturo M., Rynek usług zarządzania aktywami finansowymi, CeDeWu, Warszawa 2010
12. Treynor J. L., How to rate management of investment funds, Harvard Business
Review, 1965, No. 1.
13. Wypych M., Finanse i instrumenty finansowe, Społeczna Wyższa Szkoła
Przedsiębiorczości i Zarządzania w Łodzi – Absolwent, Łódź 2000.
Legal acts:
1. The Act of 27 August 2003 on the organization and operation of pension funds,
Journal of Laws of 2003 no. 170, item 1651 as amended.
2. The Act of 25 March 2011 on the amendment of certain laws relating to the
operation of the social security system, Journal of Laws of 2011 no. 75, item 398.
3. The Act of 28 August 1997 on investment funds, , Journal of Laws of 1997,
no. 139, item 933.
4. The Act of 23 November 2012 amending the Act on Investment Funds and the
Act on the Supervision of Financial Market, , Journal of Laws of 2013 no. 0, item 70.
Electronic bibliography:
1. www.analizy.pl
2. www.notoria.pl
Keywords: collective investor, investment fund, investment strategies, capital management,
rate of return on investment.
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