Market and Style Timing: German Equity and Bond Funds

• DOI: http://doi.org/10.1111/eufm.12080
• Date: 01 September 2016
• Published date: 01 September 2016

Market and Style Timing: German

Equity and Bond Funds

Keith Cuthbertson, Simon Hayley and Dirk Nitzsche

Cass Business School, City University London, 106 Bunhill Row, London EC1Y 8TZ

Abstract

We apply parametric and non-parametric estimates to test market and style timing

ability of individual German equity and bond mutual funds using a sample of over

500 equity and 350 bond funds, over the period 1990–2009. For equity funds, both

approaches indicate no successful market timers in the 1990–1999 or 2000–2009

periods, but in 2000–2009 the non-parametric approach gives fewer unsuccessful

market timers than the parametric approach. There is evidence of successful style

timing using the parametric approach, and unsuccessful style timing, particularly

in the 2000–2009 period. There is evidence of positive and negative bond timing in

the 2000–2009 period.

Keywords: mutual funds performance, market timing

JEL classification: C14, G11

1. Introduction

After the US, UK, Japan and France, Germany is the 5

th

largest asset management centre

in the world. Mutual fund investments in Germany account for around US$ 335 billion

under management. With ongoing political and financial restructuring it is expected that

individuals will have to become increasingly responsible for future long-term pension

savings. Therefore it is expected that the mutual fund industry will grow rapidly over the

medium term as reforms to private pension provision place greater emphasis on defined

contribution pensions (i.e., ‘Riester Rente’) and reforms result in a less generous state

pension. As in other countries such as the US and UK, mutual fund assets are

predominantly held in active funds –this paper examines whether active German equity

and bond funds engage in successful market and style timing.

Mutual fund performanceis usually discussed in terms of selectivity(alpha) and timing

and is analysed using either returns data or (where available) portfolio holdings data.

Returns-based studies may be further subdivided into parametric and non-parametric

We thank two anonymous referees who made numerous suggestions to improve the paper.

We also thank David Barr, Andrew Clare, Anil Keswani, Ian Marsh, Michael Moore,

Dylan Thomas, Lorenzo Trapani and seminar participants at the Western Economic

Association, San Francisco 2012, for discussion and comments.

European Financial Management, Vol. 22, No. 4, 2016, 667–696

doi: 10.1111/eufm.12080

© 2015 John Wiley & Sons, Ltd.

approaches. To model timing effects in the parametric approach, a factor model is

augmented with additionalnon-linear functions of the factors (Treynor and Mazuy,1966;

Henriksson and Merton, 1981). Parametric models of timing may be unconditional or

conditional on publicly available information, which allows for time-varying alphas and

factor loadings (Ferson and Schadt, 1996; Christopherson, Ferson and Glassman, 1998).

The parametric approach measures both the response to the timing signal and the

strength of that response (in terms of the size of the change in beta).The non-parametric

returns- based approach provides a measure of the quality of the manager’s forecast,

independent of the aggressiveness of the response due to changing factor loadings.

1

In this study we use a large (survivorship-bias free) sample of over 500 equity and 350

bond funds, over the last 20 years (1990–2009). The key contributions of the paper are as

follows. First we use both parametric and non-parametric approaches (Jiang, 2003) and

test for both unconditional and conditional market timing –this to our knowledge has not

been done for German funds and provides complementary evidence to the literature on

US and UK data –which itself is mainly based on parametric approaches

(Treynor-Mazuy (TM), 1966; Henriksson-Merton (HM), 1981; Ferson and Schadt,

1996; Christopherson et al., 1998). Second, for the first time, we examine style timing for

German equity funds –that is, do managers forecast the future path of small fund returns

relative to large fund returns (‘size timing’) or returns on high book-to-market relative to

low book-to-market firms (‘growth timing’) and successfully alter their weighting on

these factors, to enhance future fund returns.

2

Third, we examine the timing skills of

German equity funds with domestic, European and Global mandates –thus providing

evidence on the ‘home-bias’issue (Coval and Moskowitz, 1999; Hong et al., 2005).

Finally, we examine the market timing ability of bond funds using parametric and non-

parametric models –to the best of our knowledge the latter has not previously been

attempted for bond funds and certainly not for German bond funds.

3

Given the paucity of

empirical work on German mutual funds this substantially enhances our knowledge of

the performance of a large and growing industry in both domestic and foreign markets.

The key resultsof the paper are as follows. Using a non-parametric measurewe find both

fewer successful and fewer unsuccessful equity market timers than for the parametric

method but overall, both methods give few successful markettimers and a larger number

of funds that are negative market timers. On style timing both approaches indicate that a

substantial number of German equity funds with European or Global mandates are

unsuccessful timers of ‘size’and ‘growth’factors in the later period 2000–2009. This

suggests that the rapid growth in these international equity funds may have resulted in

managers having poor ability in forecasting markets with which they are less familiar.

Overall our non-parametric results suggest that there are few if any equity funds which

are successful market or style timers but there is stronger evidence of unsuccessful

market and style timers –particularly for European and Global mandates. For bond

1

Studies of timing that use holdings data avoid some of the potential biases in parametric

factor timing models due to interim trading and passive timing (Jiang et al., 2007; Elton et al.,

2012; Huang and Wang, 2014).

2

Although we refer to fund managers it is the performance of funds that we examine.

3

The potential role for conditioning information in the predictability of German aggregate

bond and stock indexes has been established by Hyde and Kappel (2010) –although no

specific combination of variables dominates over different sample periods.

© 2015 John Wiley & Sons, Ltd.

668 Keith Cuthbertson, Simon Hayley and Dirk Nitzsche