Financial Engineering: A Strategic Framework for Financial Innovation in Mutual Funds

Abstract

Desire for exceptionally high returns with minimal risk has been the foremost priority of a human being whenever he faces dilemma among investment avenues. Traditionally, Indian investors used to restrict their investment choice to risk free securities but in the last two decades financial markets have come up with an entirely new face. Among the several financial avenues prevailing in India, mutual funds have been admitted as the preferred choice because being flexible security it suits the self-designed boundaries of investors. Intensified competition and involvement of private players in the race of mutual funds have forced professional managers to bring innovation in mutual funds. Thus, mutual funds industry has moved from offering a handful of schemes like equity, debt or balanced funds to liquid, money market, sector specific funds, index funds and gilt edged funds. Mutual funds comprise of the strongest band of Indian financial market but have not attracted much attention, despite their efforts to continuously design new schemes. Moreover, in India sufficient work has not been done to identify the reasons why mutual funds have not been able to embed their footprints even after half a century of inception. Thus, the prime concern of this research is to identify how truly mutual fund investors appreciate this investment including identification of factors that fosters gap in investors’ expectations from security returns and actual portfolio management by mutual funds through Investor’s Risk Perception Analysis (IRPA). A well-structured comprehensive questionnaire has been designed which seeks to identify the factors responsible for creating gap in investors’ perception. Special emphasis has been given to identify mutual fund’s disclosure practices and investors’ perception about working of AMCs, as it ultimately set base for determining the risk perception. A five point Likert scale has been employed for assessing the risk perception through questionnaire. The data was analyzed using ANOVA, Chi-square and Multiple regression analysis. Results indicate that although investors admit Mutual funds as a risky investment but still optimistic about the returns they will get on their investment. Moreover, results of canonical correlation reveals that investors’ risk perception is significantly correlated with their psychological and demographic factors. Presence of rationality in human behavior always allows for acceptance of a minimum risk whereby Random Walk Hypothesis (RWH) suggests that markets have random movements which can not be predicted. Thus, crucial decision for mutual fund AMCs is to use the available information and translate that information using their skills so that investors’ trust can be maintained. For identifying current flaws in Mutual funds’ working secondary data for selected funds has been used and compared. An attempt has been made to examine the working style of mutual fund AMCs which they use to assume calculated risk as well as their capability to manage market volatility. For this purpose four mutual funds viz. SBI Mutual fund, UTI Mutual Fund, ICICI Prudential Mutual fund and Reliance Mutual fund were selected and examined. Statistical non parametric test has been applied to judge the randomness of mutual fund price movements. Further, mutual funds’ performance has been accessed during bullish and bearish trend. Results of the study have revealed that AMCs differ in their investment style to design portfolio mix and their stock selection superiority enables them to yield different returns. Moreover, it has also been revealed that mutual funds show underperformance to manage market volatility. Thus, a systematic methodology has been developed that will ensure better financial returns and ultimately help in risk management. Thus, empirical results of primary survey and result analysis of mutual fund working have been synthesized and finally a multidimensional strategic framework “FININOV” has been proposed that will allow financial products to be designed/ restructured so that mutual funds’ service style matches with investors’ expectations. This framework will also ensure the fine tuning of existing mutual funds to improve its value on risk-return calculus in response to changing market conditions. Application of research results for proliferation of mutual funds at base level has been highlighted in Indian context.