Journal of International Financial Markets, Institutions & Money

Int. Fin. Markets, Inst.
and Money 22 (2012) 11491175
Contents lists available at SciVerse ScienceDirect
Journal of International Financial

Markets, Institutions & Money
j o ur na l ho me pa ge : w w w . e l s e v i e r . c o m / l o c a t e / i n t f i n
Selectivity and timing performance of UK investment trusts

Kenbata Bangassa a,1, Chen Su b,, Nathan L. Joseph c,2
a
University of Liverpool Management School, Chatham Street, Liverpool, L69 7ZH, UK
b
Newcastle University Business School, 5 Barrack Road, Newcastle upon Tyne, NE1 4SE, UK
c
Aston Business School, Aston University, Aston Triangle, Birmingham, B4 7ET, UK
a r t i c l e i n f o a b s t r a c t
Article history: This study examines the selectivity and timing performance of 218
Received 8 April 2011 UK investment trusts over the period July 1981 to June 2009. We
Accepted 8 June 2012 estimate the Treynor and Mazuy (1966) and Henriksson and Merton
Available online 19 June 2012 (1981) models augmented with the size, value, and momentum fac-
tors, either under the OLS method adjusted with the NeweyWest
JEL classication: procedure or under the GARCH(1,1)-in-mean method following
G10 the specication of Glosten et al. (1993; hereafter GJR-GARCH-M).
G14 We nd that the OLS method provides little evidence in favour of
Keywords: the selectivity and timing ability, consistent with previous stud-
Investment trusts ies. Interestingly, the GJR-GARCH-M method reverses this result,
Selectivity and timing showing some relatively strong evidence on favourable selectivity
GJR-GARCH-M ability, particularly for international funds, as well as favourable
Conditional asymmetry timing ability, particularly for domestic funds. We conclude that
High frequency data the GJR-GARCH-M method performs better in evaluating fund per-
formance compared with the OLS method and the non-parametric
approach, as it essentially accounts for the time-varying character-
istics of factor loadings and hence obtains more reliable results, in
particular, when the high frequency data, such as the daily returns,
are used in the analysis. Our results are robust to various in-sample
and out-of-sample tests and have valuable implications for practi-
tioners in making their asset allocation decisions across different
fund styles.
2012 Elsevier B.V. All rights reserved.
Corresponding author. Tel.: +44 0191 208 1656.

E-mail addresses: kenbata@liv.ac.uk (K. Bangassa), chen.su@ncl.ac.uk (C. Su), n.l.joseph@aston.ac.uk (N.L. Joseph).
1
Tel.: +44 0151 795 3506.
2
Tel.: +44 0121 204 3143.
1042-4431/$ see front matter 2012 Elsevier B.V. All rights reserved.
http://dx.doi.org/10.1016/j.intn.2012.06.001
1150 K. Bangassa et al. / Int. Fin. Markets, Inst. and Money 22 (2012) 11491175
1. Introduction
Investment trusts have been playing an important role as the nancial intermediation since the
launch of the rst ever publicly listed investment trust, Foreign and Colonial Investment Trust, in 1868.
They raise funds from individual as well as institutional investors by issuing shares and in turn invest
the funds raised in a portfolio of assets held by other rms.3 It is often argued that investors who hold
shares of investment trusts benet from fund managers managerial skills, which can be interpreted as
the selectivity ability to pick successful stocks and/or the timing ability to correctly forecast the market
movement. Although the number and the proportion of investment trusts in relation to the size of
trade that takes place on the London Stock Exchange (LSE) are substantial,4 very little research has
been conducted on the selectivity and timing performance of UK investment trusts. Extant studies on
UK investment trusts are limited from both the out-of-date sample examined and the simplicity of
the models as well as estimation methods employed to test the fund performance. For example, in
examining the performance of 72 investment trusts over the period 19741993 under the ordinary
least squares (OLS) as well as generalised least squares (GLS) methods, Leger (1997) nds slightly
positive selectivity ability, but signicantly negative timing performance for about one third of funds.
Bangassa (1999) investigates the performance of 79 investment trusts over the period 19801994
under the OLS method. Empirical results indicate the existence of unfavourable market timing ability,
but many trusts do not exhibit signicantly positive or negative selectivity ability, consistent with
early studies on fund performance.5
These early studies on mutual fund performance generally employ the basic Treynor and Mazuy
(1966; hereafter T-M) and Henriksson and Merton (1981; hereafter H-M) models under the stan-
dard OLS method. These basic models are assumed to be well specied and the estimation method is
assumed to have properties that are consistent with the underlying data generating process, so two
major econometric problems inevitably arise with the use of this approach. First, as Fama (1998) states,
model misspecication can lead to unreliable statistical inferences and in turn might provide supports
for the superior or inferior fund performance, when indeed this is not the case. Second, the inappro-
priate assumption that the estimation method is consistent with the data generating process can lead
to incorrect statistical inferences about the relative level of fund performance. That is, although the
coefcient estimations under the OLS method remain unbiased when residual heteroscedasticity is
present, the condence intervals based on the standard errors will be incorrect. To address both issues
and to generate more robust empirical results in this study, we augment the basic T-M and H-M models
with the size and value factors developed by Fama and French (1993) as well as the momentum factor
proposed by Carhart (1997).6 We initially estimate both augmented models under the OLS method
with the NeweyWest procedure to correct for the residual heteroscedasticity and autocorrelation.
Based on a relatively large sample of 218 UK investment trusts over the very long period July 1981
to June 2009, we nd little evidence on favourable selectivity and timing ability, but unfavourable
3
The shares issued by investment trusts are xed and the companies are not required to redeem them. Hence, depending
on the supply and demand, the price of the investment trust shares could be different from the price of their underlying assets
(trading at a premium or discount). Investment trusts are closed-end funds usually listed on a stock exchange. Unit trusts are
collective investment whereby the units represent the proportional value due to the investor from the investment holdings
and the periodic prots made. The market value of the underlying assets and the total value of the units are identical unlike
the shares of investment trusts that can be traded at a discount or premium. The unit trusts are also required to repurchase the
shares issued if the shareholders wish to do so. These redeemable securities will terminate and dissolve at the predetermined
time period. A mutual fund is a company that raises funds from investors and invests the funds raised in stocks, bonds, or other
assets. Investors in these funds hold shares that represent their proportionate ownerships from the portfolio of a mutual fund.
4
At 31 December 2011, the investment trust industry consisted of 412 funds with total assets of 90.3 billion and market
capitalisations of 68.6 billion.
5
See, e.g., Treynor and Mazuy (1966), Alexander and Stover (1980), Lehmann and Modest (1987), Grinblatt and Titman
(1989), Lee and Rahman (1990), and Daniel et al. (1997) for the US mutual funds as well as Brown et al. (1992) and Allen and
Tan (1999) for the UK pension funds.
6
For example, Carhart (1997) shows that the inclusion of the momentum factor in the Fama and French (1993) three-factor
model almost completely explains the persistence in US mutual funds. Fletcher and Forbes (2002) also nd that the persistence
in UK unit trusts performance is eliminated when using the Carhart (1997) four-factor model.
K. Bangassa et al. / Int. Fin. Markets, Inst. and Money 22 (2012) 11491175 1151
timing ability, consistent with previous studies on US mutual funds and UK unit trusts.7 Importantly,
the average returns for the aggregate portfolio and nine fund styles are all signicantly exposed to the
size, value, and momentum factors, demonstrating that the three factors that mimic the underlying
risks are important to investors.
The low frequency data, e.g., the monthly, quarterly, or yearly returns, are often employed by pre-
vious studies on mutual fund performance (see, e.g., Cuthbertson et al., 2010a, for a survey), while, as
discussed by Goetzmann et al. (2000), the low frequency returns might fail to capture the contribu-
tion of fund managers timing performance, since decisions regarding market exposure are likely to
be made more frequently than monthly for most funds. This study, therefore, uses the daily returns to
account for the vantage of fund managers who are likely to rebalance their portfolios at more frequent
intervals, e.g., the daily basis.8 Although the use of the high frequency data is supposed to be able
to more accurately reect the actual investment returns on a fund, the assumptions that time series
returns are normal and independently and identically distributed (iid) and that there is no serial cor-
relation in the observed investment returns are rejected as the daily returns contain more pronounced
ARCH and asymmetric effects than the monthly returns (see, e.g., Baillie and Bollerslev, 1989; Bollen
and Busse, 2001; Dimson and Jackson, 2001).9 Time-varying conditional volatility and asymmetry in
the daily returns can arise from several sources including the return generating process, passive man-
agement strategies, and adjustments to portfolio weights, which are likely to have important impacts
on fund performance (see, e.g., Ferson and Schadt, 1996).
Given that daily returns contain more pronounced ARCH/GARCH and asymmetry effects than the
monthly returns, the OLS method will generate inefcient coefcient estimations although the esti-
mates will still be unbiased. Adjusting the standard errors with the use of the NeweyWest procedure
to correct for heteroscedasticity and autocorrelation does not fully capture the time-varying condi-
tional volatility and down-side (asymmetric) risks that have direct inuence on fund performance
and portfolio choice,10 some more recent studies apply the cross section bootstrap statistical tech-
nique to simulate the timing and selectivity estimations in order to determine the reliability of the
estimated condence intervals. For example, Kosowski et al. (2006) provide a thorough analysis of the
bootstrap simulation methodology, which allows for non-normality in the idiosyncratic risk of funds.
Cuthbertson et al. (2008) report the existence of stock picking ability for a relatively small number of
top performing UK equity mutual funds, but not for small stock funds or for all company funds. Fama
and French (2010, p. 1915) conclude that few funds produce benchmark-adjusted expected returns suf-
cient to cover their costs.11 In addition, Jiang (2003) proposes a non-parametric approach to measure
the market timing ability of portfolio managers, which is claimed to be able to avoid the potentially
biased timing estimation due to the statistical problems of heteroscedasticity or skewness. Using the
non-parametric approach, Cuthbertson et al. (2010b) report a relatively small number (around 1%) of
UK unit trusts exhibiting positive market timing ability and around 19% of funds exhibiting negative
timing ability. After controlling for the publicly available information, they nd very little evidence of
7
See, e.g., Cuthbertson et al. (2010a) for a critical review of empirical studies on the performance of US mutual funds as well
as UK unit trusts and Barberis and Thaler (2003) for a survey of recent work on the performance of closed-end funds.
8
Dan Jelicic, the principal of Sabre Fund Management, emphasised the importance of fund managers in rebalancing their
portfolios at more frequent intervals in April 2009, we have an edge, [since] we can reallocate on a daily basis whereas many of
our competitors rebalance only monthly.
9
Joseph (2003) nds signicant conditional ARCH effects contained in the monthly data. Fuertes and Thomas (2006) argue
that the prices of UK closed-end funds overreact to their relative net asset values of the funds and the revisions to pre-shock
values are slower for market-wide shocks compared with fund specic shocks.
10
Residual correction method assumes that a true correction can be made when heteroscedasticity and autocorrection exist
in the variance/covariance matrix of the estimations. The Newey-West method assumes that the coefcients are correctly
estimated even if the variance/covariance matrix generated for the same coefcients are considered to be problematic. The
point of view seems to be incorrect, econometrically (see, e.g., Fletcher and Forbes, 2002).
11
Although the use of simulations appears to be a promising approach, a simple count of all funds with signicant t-statistics
ignores the possibility of some signicant funds due to false discoveries (Storey, 2002). Following the methodology of Barras
et al. (2010) to assess the overall mutual fund performance, Cuthbertson et al. (2012) nd that there is much higher proportion
of the false discoveries among the best funds than among the worst funds, demonstrating that the standard method of simply
counting the number of funds with signicant t-statistics can be far more misleading for winners than for losers.
successful market timing based on private information by mutual funds, similar to the results of UK
pension funds (see, e.g., Clare et al., 2010).
This study supplements the existing literature in performance evaluation by introducing the asym-
metric GARCH(1,1)-in-mean (GARCH-M) method, following the specication suggested by Glosten
et al. (1993, hereafter GJR-GARCH-M), which takes the ARCH and asymmetric effects into account and
thus enables us to more effectively assess both effects on the daily returns.12 The GJR-GARCH-M spec-
ication contains an additional parameter for conditional asymmetry between return and volatility,
which allows the conditional variance to respond differently to the past negative and positive innova-
tions and essentially captures the underlying data generating process of the data used in the estimation
(Arvanitis and Demos, 2004). We are not aware of any previous study that employs the asymmetric
GARCH-M method to evaluate the selectivity and timing performance of closed-end funds, despite the
exibility of such estimation method. We believe that it is worthwhile to explore the time-varying
properties of fund returns since the time-varying effects can affect the fund performance and portfolio
choice.
We apply the GJR-GARCH-M method for the following major considerations. First, if we can show
empirically that the timing and selectivity abilities of fund managers are a source of superior per-
formance, it may be possible to justify the activities of fund managers. However, to arrive at this
conclusion, we need to be sure that the performance measures used and how they are estimated are
econometrically sound. Otherwise, we may conclude that fund managers have superior timing and
selectivity skills while in fact this is not the case (see, e.g., Fama, 1998). In addition, although the aug-
mented T-M and H-M models appear to lead to more improved model specication (see e.g., Carhart,
1997; Fletcher and Forbes, 2002), the failure to capture both conditional ARCH and asymmetric effects
in the daily returns can still give rise to misleading results. The point here is that the fund returns can
depend on their volatility (see, e.g., French et al., 1987; Chou, 1988). Hence, the estimation method
needs to capture both the time-varying conditional volatility and asymmetry that affect the returns.
Taking conditional volatility and asymmetric effects into account, the GJR-GARCH-M method enables
us to assess how these factors impact on the timing and selectivity performance and whether fund
managers are able to anticipate the downward price movements associated with volatility and thereby
minimise their effects on fund returns. Overall, it is essential that not only should the pricing model
be correctly specied, but also that the estimation method captures the underlying data generating
process in order to lead to correct statistical inferences.
Our results under the GJR-GARCH-M method reverse those obtained under the OLS method, demon-
strating some strong evidence on the selectivity and timing performance for UK investment trusts. For
example, we nd a substantial increase in the number of investment trusts with favourable selectivity
ability under the GJR-GARCH-M method. Specically, for the augmented H-M model, 73 (33.49%) of
218 individual funds exhibit signicantly positive selectivity ability under the GJR-GARCH-M method,
compared with 10 (4.59%) individual funds under the OLS method. This is our strongest evidence in
support of selectivity ability and this result is much stronger than what has been reported in Leger
(1997) and Bangassa (1999). Similarly, for the augmented T-M model, 88 (40.37%) individual funds
exhibit favourable timing ability under the GJR-GARCH-M method, compared with two (0.92%) indi-
vidual funds under the OLS method. Various in-sample robustness tests, i.e., the use of the basic H-M
and T-M models and/or the two equal sub-periods, and out-of-sample tests over a two-year window
from 1 July 2009 to 30 June 2011 show that our empirical results are materially unchanged. More-
over, using the non-parametric approach proposed by Jiang (2003), we nd no evidence of superior
market timing ability of UK investment trusts, suggesting that the non-parametric approach does not
explicitly capture and model the stylised behaviour of returns, i.e., volatility clustering and conditional
skewness. We, therefore, conclude that the selectivity and timing performance of UK investment trusts
are sensitive to the choice of estimation methods and the GJR-GARCH-M method is more appropriate
in evaluating the fund performance as it essentially accounts for the time-varying characteristics of
12
The ARCH-in-mean (ARCH-M) specication of Engle et al. (1987) extends the ARCH specication of Engle (1982) by allowing
the conditional mean to depend directly on the conditional variance. The GARCH-M specication adds a heteroscedasticity term
into the ARCH(1,1)-in-mean (ARCH-M) specication to capture the past volatility.
factor loadings and hence obtains more reliable results, particularly, when the high frequency data,
such as the daily returns, are used in the analysis.
Finally, we nd that the evidence on the selectivity and timing performance under the GJR-GARCH-
M method varies by fund styles. In particular, the international fund styles (e.g., Asia Excluding Japan,
Europe, Global Growth, and Global Growth & Income) exhibit stronger selectivity ability than other
domestic fund styles (e.g., UK Growth, UK Growth & Income, UK High Income, and UK Small Company).
We attribute this to the benets from the internationally diversied portfolios and from the greater
growth of stock returns in the international markets. In contrast, domestic fund styles outperform all
other fund styles in respect of timing ability, which can be explained by the more severe information
asymmetry in the international market that makes it more difcult for fund managers to correctly
predict the market movement.
The remaining sections of this study are organised as follows. The following section describes the
data and presents empirical models used in the study. Sections 3 and 4 discuss empirical results and
conduct various robustness tests, respectively. The nal section concludes.
2. Data and methodology
2.1. Data and descriptive statistics
To perform the analysis, we collect the daily returns for UK investment trusts traded on the LSE
over the period 1 July 1981 to 30 June 2009. The sample period spans the full global nancial crisis
period, beginning with the Quant Meltdown in the summer of 2007 and ends with the trough of the
stock market in March 2009 (see, Ben-David et al., 2012).13 A total of 505 observations in a two-year
window from 1 July 2009 to 30 June 2011 are used for the out-of-sample test. This study deals with
an entire set of 218 investment trusts with available data in DataStream, including 34 non-surviving
funds to avoid the potential survivorship bias.14 To check whether the funds that focus on a particular
investment objective result in improved selectivity and timing performance, we also categorise all
investment trusts into nine groups according to the specic fund styles dened by the Association of
Investment Trust Companies (AITC).15
Descriptive statistics in Table 1 show that the mean daily excess returns as well as skewness and
kurtosis for the mean excess returns are signicantly positive for the aggregate portfolio and each
fund style. Also, on the right side of Table 1, we report the number of individual investment trusts in
each fund style that have statistically signicant daily excess return as well as skewness and kurtosis
for the mean excess return, i.e., (+) and () represent signicantly positive and negative, respec-
tively, at the 10% level. Specically, 140 (64.22%) and 23 (10.55%) of 218 individual funds exhibit
signicantly positive and negative mean excess returns, respectively. All individual funds exhibit sig-
nicantly positive kurtosis; 149 (68.35%) and 37 (16.97%) individual funds exhibit signicantly positive
and negative skewness, respectively. The tendency for the excess returns to exhibit substantially more
positive skewness than negative skewness indicates the opportunities for the funds to benet from
price increases. The Q-statistics for the square returns suggest strong evidence of ARCH effects in the
raw returns (see, e.g., Engle, 2001).
13
In a previous version of this paper, we examine the sample containing the pre-nancial crisis data over the period 1 July
1981 to 30 June 2007, indicating consistent results, which are not reported for the sake of brevity, but available on request.
14
Empirical work provides mixed results on the severity of the survivorship bias (see, e.g., Brown and Goetzmann, 1995;
Malkiel, 1995; Blake and Timmermann, 1998). The results presented in this study are based on surviving and non-surviving
investment trusts combined. We also examine the sample that exclusively consists of surviving funds and nd similar results.
Empirical results based only on surviving funds are not reported for the sake of brevity, but available on request. Therefore, the
non-survivorship bias is essentially trivial or small in this study.
15
Lakonishok et al. (1992) argue that the well-dened styles seem to have an important impact on the fund performance.
1154
K. Bangassa et al. / Int. Fin. Markets, Inst. and Money 22 (2012) 11491175
Table 1
Descriptive statistics of the daily excess returns for the aggregate portfolio and fund styles.
N Mean Min Max Std. Dev. Skewness Kurtosis Mean =
/ 0 at 10% Skewness =
/ 0 at Kurtosis =
/ 3 at Auto (2)
10% 10%
Asia Excluding Japan 12 0.00072 (4.57)a 0.2049 0.1682 0.0196 0.1061 (2.27)b 10.3738 (81.91)a 10+ 0 7+ 0 12+ 0 431.87a
Europe 8 0.00057 (5.24)a 0.2092 0.1828 0.0136 0.2017 (4.53)a 21.4777 (151.42)a 8+ 0 6+ 0 8+ 0 391.24a
Global Growth 32 0.00077 (4.67)a 0.2028 0.1711 0.0137 0.2601 (5.57)a 21.2960 (173.24)a 24+ 0 25+ 6 32+ 0 460.36a
Global Growth & Income 7 0.00074 (6.08)a 0.2017 0.1696 0.0145 0.3003 (6.36)a 20.2178 (171.04)a 6+ 0 6+ 0 7+ 0 479.56a
Japan 5 0.00072 (4.35)a 0.2007 0.1610 0.0206 0.1953 (4.18)a 7.2760 (61.56)a 2+ 1 3+ 1 5+ 0 382.03a
UK Growth 21 0.00064 (4.12)a 0.2088 0.1717 0.0129 0.2531 (5.42)a 21.1569 (178.99)a 16+ 2 17+ 2 21+ 0 477.60a
UK Growth & Income 22 0.00057 (6.79)a 0.2096 0.1762 0.0105 0.3879 (8.30)a 20.1721 (170.66)a 15+ 3 16+ 3 22+ 0 455.90a
UK High Income 9 0.00057 (6.44)a 0.2062 0.1664 0.0123 0.5854 (10.47)a 31.8232 (262.42)a 7+ 0 8+ 0 9+ 0 342.34a
UK Small Companies 18 0.00058 (6.87)a 0.2081 0.1583 0.0140 0.4978 (8.52)a 33.2093 (210.72)a 12+ 2 15+ 2 18+ 0 484.91a
Others 84 0.00049 (4.48)a 0.2072 0.2125 0.0135 0.5770 (12.35)a 23.9944 (202.99)a 40+ 15 42+ 23 84+ 0 292.46a
All 218 0.00062 (7.47)a 0.2050 0.1645 0.0138 0.2661 (5.93)a 22.4575 (189.99)a 140+ 23 149+ 37 218+ 0 467.04a
The excess returns are for a total of 218 UK investment trusts according the aggregate portfolio and various fund styles, over the period July 1981 to June 2009. Auto (2) denotes the
Q-statistic for autocorrelation based on the square of the aggregate returns at two lags. The t-statistics are reported in parentheses. The numbers on the right side of the table represent
the count of individual investment trusts in each fund style that have statistically signicant daily excess return as well as skewness and kurtosis for the mean excess return, i.e., + and
represent signicantly positive and negative, respectively, at the 10% level.
a
Statistical signicance at the 1% level.
b
2.2. Methodology
Ferson and Schadt (1996) argue that the traditional measures of performance designated to exam-
ine the selectivity and timing ability of mutual funds generally fail to take into account the common
time variations in returns and risk premiums. The Carhart (1997) four-factor model, which comprises
of the size and value factors provided by Fama and French (1993) as well as the momentum factor
to account for continuation patterns in stock returns documented by Jegadeesh and Titman (1993),
has been demonstrated to be able to capture a part of the time-varying nature of returns and risk
premiums.16 We, therefore, augment the basic T-M and H-M models with the size, value, and momen-
tum factors, in order to provide greater explanatory power than the basic models. The augmented T-M
and H-M models are, respectively, presented as
Zj,t = j + j Zm,t + j (Zm,t )2 + j SMBt + j HMLt + j MOMt + j,t , (1)
and
Zj,t = j + j Zm,t + j {max(Zm,t , 0)} + j SMBt + j HMLt + j MOMt + j,t , (2)
where Zj,t = Rj,t Rf,t is the excess daily return on fund j17 ;
Rj,t = (RIj,t Rj,t1 )/RIj,t1 where RIj,t is the
fund return index inclusive of dividend on the day t; Zm,t = Rm,t Rf,t is the overall excess daily return
on the FTSE All Share Index where Rj,t = (RIm,t Rm,t1 )/RIm,t1 ; Rf,t is the daily de-annualised three-
month UK Treasury Bill rate; SMBt is the daily return on a zero-investment portfolio for the size factor,
namely the difference in returns between a big size rm portfolio and a small size rm portfolio; HMLt
is the daily return on a zero-investment portfolio for the value factor, namely the difference in returns
between a portfolio of high B/M stocks and a portfolio of low B/M stocks18 ; MOMt is the daily return
on a zero-investment portfolio for the momentum factor, namely the difference in returns between a
portfolio of past winner stocks and a portfolio of past loser stocks19 ; j,t denotes the error term.
Both the augmented T-M and H-M models are initially estimated under the standard OLS method
with the NeweyWest procedure used to correct for the residual heteroscedasticity and autocorrela-
tion. The selectivity ability is measured by the intercept term j , while j captures the timing ability.
Both coefcients are expected to be signicantly positive if a fund manager has favourable selectivity
and/or timing ability. That is, if a fund manager increases (decreases or closes-out) his/her holdings
of risky assets or changes the weight of risky assets held ahead of a positive (negative) Zm,t , j should
16
A growing body of empirical evidence has demonstrated the capability of the size, value, and momentum factors in capturing
the major anomalies of the single-factor CAPM in the US market (see, e.g., Daniel et al., 1997; Chevalier and Ellison, 1999; Bollen
and Busse, 2005; Kacperczyk et al., 2005; Avramova and Chordia, 2006) and in the UK market (see, e.g., Blake and Timmermann,
1998; Quigley and Sinqueeld, 2000; Tonks, 2005; Cuthbertson et al., 2008; Brookeld et al., 2012).
17
We use the subscript j to denote the relevant statistic for an individual fund. Where appropriate, we also use the subscript
p to denote the statistic associated with the aggregate portfolio or each fund style.
18
Following Fama and French (1993), we construct portfolios that mimic the size and value factors in the UK stock market. On
30 June of each year t from 1980 to 2011, all available stocks listed on the LSE (excluding nancial rms, such as banks, insurance
rms, real estate rms, and other nancial service rms) are divided into two size groups, small (S) or big (B), according to
whether their market values are below or above the median market value of all stocks. All stocks are also divided into three
value groups, high B/M (H), medium B/M (M), or low B/M (L), according to whether the values of their B/M at the end of year
t 1 are included in the top 30, middle 40, or bottom 30 percentile, respectively. Finally, we construct six portfolios, SL, SM,
SH, BL, BM, and BH, from the intersections of two size groups and three value groups in June of year t and calculate daily
value-weighted returns on the six portfolios from July of year t to June of year t + 1. For example, SL portfolio contains stocks in
both the small-size group and the low-B/M group, and BH portfolio contains stocks in both the big-size group and the high-B/M
group. SMB represents the return on a zero-investment portfolio formed by subtracting the mean return on three big-size rm
portfolios (BL, BM, and BH) from the mean return on three small-size rm portfolios (SL, SM, and SH), and HML represents the
return on a zero-investment portfolio formed by subtracting the mean return on two low-B/M rm portfolios (SL and BL) from
the return on two high-B/M rm portfolios (SH and BH).
19
Following Jegadeesh and Titman (1993) and Carhart (1997), we construct the momentum factor. MOM represents the equal-
weighted return on a zero-investment portfolio formed by subtracting the mean return on a loser portfolio composed of stocks
with the lowest 10% eleven-month returns lagged one month from the mean return on a winner portfolio composed of stocks
with the highest 10% eleven-month returns lagged one month. All empirical results in this paper are qualitatively similar when
using the alternative momentum factor based on winner and loser portfolios composed of stocks with the highest and lowest
30% eleven-mouth returns lagged one month, respectively.
be positive denoting superior timing ability. Alternatively, j is likely to capture a fund managers
contribution to timing if his/her portfolios beta is linearly related to his/her timing signal (see, e.g.,
Admati et al., 1986). In Eq. (2), Zm,t takes on a value of zero if it is positive and Zm,t , if the market
return drops below the risk free rate. Thus j has the special meaning of an implicit protective put
option that is predicted to be positive if a fund manager has timing ability. Henriksson (1984) argues
that j will be a good proxy for timing ability as long as Zm,t is highly correlated with the true market
return.
Table 2 presents some strong statistical features of explanatory variables used in Eqs. (1) and (2).
For example, the signicant kurtosis and skewness suggest non-normal distribution of observations
for all explanatory variables. Also, the signicant Q-statistics for the square of the variables suggest
strong ARCH effect. Therefore, the use of the OLS method can adversely affect estimation efciency
when the data contain ARCH and asymmetric effects. The NeweyWest corrections fail to capture
time-varying conditional volatility and down-side (asymmetric) risk, which can directly affect returns
and therefore the fund performance and portfolio choice. Arvanitis and Demos (2004) argue that
the inclusion of conditional variance in the GARCH-M method tends to have favourable impacts on
skewness and kurtosis in conditional errors. Thus, to eliminate potential ARCH and asymmetric effects
on the relationship between the return of the fund and its risk, we further estimate both augmented
T-M and H-M models under the GJR-GARCH-M method, which enables us to capture the theoretical
prediction of a positive relation between the mean return of an asset and its variance. As such, we
expect the GJR-GARCH-M method to outperform the OLS method, since the estimation efciency will
increase under the GJR-GARCH-M method.
To specify the GJR-GARCH-M method, we re-state Eqs. (1) and (2), respectively, for the augmented
T-M and H-M models with the inclusion of the conditional variance j,t , thus
Zj,t = j + j Zm,t + j (Zm,t )2 + j SMBt + j HMLt + j MOMt + j ln(h2j,t ) + j,t , (3)
and
Zj,t = j + j Zm,t + j {max(Zm,t , 0)} + j SMBt + HMLt + j MOMt + j ln(h2j,t ) + j,t , (4)
where ln(h2j,t ) is the natural log of the conditional variance j,t ; other variables are as dened in Eqs.
(1) and (2). The coefcient j , which is interpreted as a measure of time-varying risk premium or risk
tolerance, captures the conditional risk associated with the mean return. The conditional variance
h2j,t = Var(j,t |t1 ) can be written as:
h2j,t = Var(j,t |t1 ) = j + j 2j,t1 + j Sj,t1

2
2j,t1 +
i h2j,t1 , (5)
where j is the coefcient for the permanent component of conditional variance; the coefcients j
and j , respectively, capture the impacts of past news and lagged conditional volatility on current
conditional volatility h2j,t ; the coefcient j captures the asymmetric impact of news, such that Sj,t1
2
is a dummy variable set to 1 if 2j,t1 is negative, and 0 otherwise. That is, j captures the asymmetric
effect following negative news, so a signicantly positive (negative) coefcient j indicates that a
fund manager is unable (able) to avoid the source of conditional risk. The GJR-GARCH-M method is
estimated under the assumption that the conditional errors follow a generalised error distribution. Eq.
(5) is an important element of any estimation method using the GARCH family. Indeed, the nding of
signicant coefcients in Eq. (5) provides additional evidence of conditional variance and asymmetry
effects on fund returns and further justies the use of the GJR-GARCH-M method.
3. Empirical results and analyses
This section presents the main empirical results on the selectivity and timing performance of UK
investment trusts by estimating both the augmented T-M and H-M models under the OLS method
adjusted with the NeweyWest procedure and the GJR-GARCH-M method. In addition, we examine
the parameters of the conditional variance of the two augmented models.
Table 2
Descriptive statistics of explanatory variables used in both augmented T-M and H-M models.
N Mean Min Max Std. Dev. Skewness Kurtosis Auto (1) Auto (2) Auto (3) Auto (4) Auto (5)
Rm,t Rf,t 7124 0.00046 (2.54)b 0.2295 0.2023 0.0142 0.2946 (6.30)a 18.5604 (157.02)a 383.82a 393.46a 406.98a 444.15a 455.94a
max(Zm,t , 0) 7124 0.00433 (46.79)a 0.0000 0.2295 0.0092 4.1019 (87.79)a 37.6658 (318.66)a 1.11 1.20 128.75a 8.80a 13.41a
SMBt 7124 0.00064 (5.74)a 0.0485 0.1143 0.0093 0.7583 (16.23)a 8.3793 (70.89)a 171.85a 293.93a 378.54a 437.75a 512.67a
HMLt 7124 0.00322 (15.53)a 0.2970 0.2470 0.0172 1.4479 (30.99)a 37.6735 (318.72)a 5.12a 13.41a 20.19a 22.65a 25.43a
MOMt 7124 0.00092 (4.38)a 0.2895 0.2173 0.0174 1.3449 (28.78)a 27.4694 (232.39)a 6.29a 16.46a 20.83a 26.72a 33.73a
The excess returns are for a total of 218 UK investment trusts according the aggregate portfolio and various fund styles, over the period July 1981 to June 2009. Auto (n) denotes the
Q-statistic for autocorrelation based on the square of the variables at various lags. The t-statistics are reported in parentheses.
a
b
1157
3.1. OLS method using the augmented T-M and H-M models
We initially examine the performance of UK investment trusts using both augmented T-M and H-M
models under the OLS method over the whole sample period July 1981 to June 2009, but nd little
evidence on favourable selectivity or timing ability, irrespective of the model used. For example, Panel
A of Table 3a shows that both the aggregate portfolio and each fund style exhibit no positive selectivity
ability for the augmented T-M model, while two domestic fund styles (UK Growth and UK Small
Companies) exhibit signicantly negative selectivity ability at the 10% level. The numbers indicated in
Panel B represent the count of investment trusts that show favourable (+) or unfavourable () values for
various parameter estimations. Specically, nine (4.13%) of 218 individual funds exhibit signicantly
positive selectivity ability, while 43 (19.72%) individual funds exhibit signicantly negative selectivity
ability. In addition, all timing coefcients are statistically insignicant for both the aggregate portfolio
and nine fund styles. Only two (0.92%) individual funds show favourable timing ability, while six
(2.75%) individual funds show unfavourable timing ability.20
Compared with the evidence shown in Table 3a, very similar results are presented in Panels A
and B of Table 3b for the augmented H-M model under the OLS method, in terms of little evidence of
favourable selectivity or timing ability and in terms of the frequencies of signicant coefcients across
the factors, consistent with previous US and UK studies as well as other international studies.21
3.2. GJR-GARCH-M method using the augmented T-M and H-M models
Tables 4a and 4b show that although both residual autocorrelation and ARCH effects still exist under
the GJR-GARCH-M method, the degree of associated statistics for the aggregate portfolio and each
fund style is much smaller compared with those under the OLS method.22 Thus, in this study, the GJR-
GARCH-M method does capture a part of the ARCH effect and serial correlation in conditional volatility.
Importantly, some evidence on favourable selectivity and timing ability presented in Tables 4a and 4b
strongly suggests that the performance evaluation under the GJR-GARCH-M method is preferred over
the OLS method.23
Panel A of Table 4a shows that three international fund styles (e.g., Asia Excluding Japan, Global
Growth, and Global Growth & Income) exhibit signicantly positive selectivity coefcients for the
augmented T-M model. Also, Panel B reports the count of investment trusts that show favourable (+)
or unfavourable () values for various parameter estimates. Specically, 39 (17.89%) of 218 individ-
ual funds exhibit signicantly positive selectivity ability, while 18 (8.26%) individual funds exhibit
signicantly negative selectivity ability. In addition, the augmented T-M model also provides strong
support for the timing ability under the GJR-GARCH-M method. For example, Panel A shows that four
domestic fund styles (e.g., UK Growth, UK Growth & Income, UK High Income, and UK Small Com-
panies) exhibit signicantly positive timing coefcients, which is the strongest evidence in support
of favourable timing ability observed in this study, while four international fund styles (e.g., Asia
Excluding Japan, Europe, Global Growth, and Global Growth & Income) exhibit signicantly negative
20
Results presented in Panel A of Table 3a also show that the average returns for the aggregate portfolio and nine fund
styles are all signicantly exposed to the size factor (SMBt ), value factor (HMLt ), and momentum factor (MOMt ). In addition, the
frequency of the signicant coefcients presented in Panel B of Table 3a consistently shows that the coefcients for SMBt , HMLt ,
and MOMt , are signicantly positive for 207 (94.95%), 139 (63.76%), and 150 (68.81%) individual funds, respectively, for the
augmented T-M model. Very similar results can be found in Table 3b. Therefore, different from previous studies suggesting the
lack of power of the size and value factors (see, e.g., Ferson et al., 1999) and the momentum factor (see, e.g., Liew and Vassalou,
2000) in explaining cross-sectional variations in stock returns, our results provide new evidence demonstrating that the three
factors have an important impact on fund excess returns.
21
See, e.g., Grinblatt et al. (1995), Carhart (1997), Wermers (2000), and Pastor and Stambaugh (2002) for US mutual funds;
Fletcher (1995), Becker et al. (1999), Fletcher and Forbes (2002), and Byrne et al. (2006) for UK unit trusts; Holmes and Faff
(2008) for the Australian market; and Carlos and Cortez (2006) for the Portuguese market.
22
The presence of autocorrelation and ARCH effects is not surprising, since the estimations based on the GARCH family still
leads to some neglected linearity in the conditional residuals (Joseph, 2003).
23
As before, the vast majority of individual funds exhibit signicantly positive exposures to the size factor (SMBt ), value factor
(HMLt ), and momentum factor (MOMt ) for both augmented T-M and H-M models.
Table 3a
OLS methods for the selectivity and timing performance for the augmented T-M model: July 1981 to June 2009.
Style N p p p p p p R2 AUTO (2) ARCH (1)
Panel A: Estimations for the aggregate portfolio and fund styles
Asia Excluding Japan 12 0.00011 (1.28) 0.5446 (31.65)a 0.1594 (0.25) 0.0800 (6.42)a 0.0293 (3.18)a 0.0208 (3.33)a 0.5195 22.95a 490.61a
Europe 8 0.00011 (0.54) 0.6906 (20.89)a 0.1493 (0.13) 0.1157 (4.69)a 0.0499 (2.50)b 0.0511 (4.35)a 0.2323 13.28a 9.39a
Global Growth 32 0.00003 (0.34) 0.4229 (28.45)a 0.1572 (0.31) 0.1735 (11.84)a 0.0579 (2.67)a 0.0175 (2.69)a 0.4133 20.10a 230.36a
Global Growth & Income 7 0.00005 (0.43) 0.2970 (20.09)a 0.2472 (0.29) 0.1210 (9.54)a 0.0192 (8.47)a 0.0192 (3.24)a 0.2405 14.17a 262.84a
Japan 5 0.00002 (0.24) 0.4593 (27.02)a 0.1897 (0.32) 0.2043 (12.56)a 0.0152 (5.46)a 0.0246 (3.00)a 0.4372 23.86a 116.28a
UK Growth 21 0.00017 (1.72)c 0.5627 (41.17)a 0.1808 (0.45) 0.1094 (9.70)a 0.0467 (2.91)a 0.0387 (7.48)a 0.6270 34.59a 115.18a
UK Growth & Income 22 0.00013 (1.25) 0.5634 (33.25)a 0.1584 (0.30) 0.0980 (8.09)a 0.0115 (6.53)a 0.0306 (4.98)a 0.5947 5.52a 83.92a
UK High Income 9 0.00038 (1.49) 0.6922 (20.69)a 0.4343 (0.45) 0.1892 (7.51)a 0.0116 (2.84)a 0.0214 (3.88)a 0.2780 55.39a 131.29a
UK Small Companies 18 0.00030 (1.71)c 0.6195 (25.97)a 0.2408 (0.34) 0.1402 (7.79)a 0.0818 (3.08)a 0.0373 (4.93)a 0.4442 31.65a 312.49a
Others 84 0.00019 (1.52) 0.6031 (23.64)a 0.3052 (0.29) 0.1817 (8.64)a 0.0106 (3.60)a 0.0693 (4.42)a 0.4409 54.43a 52.22a
All 218 0.00014 (1.40) 0.5509 (34.40)a 0.2136 (0.46) 0.1492 (11.55)a 0.0425 (2.14)b 0.0561 (8.23)a 0.6023 25.13a 231.71a
Style N j =
/ 0 j =
/ 0 j =
/ 0 j =
/ 0 j =
/ 0 j =
/ 0
Panel B: Frequency count of signicant coefcients for individual funds
Asia Excluding Japan 12 0+ 1 12+ 0 0+ 0 12+ 0 5+ 1 6+ 0
Europe 8 0+ 1 8+ 0 0+ 0 8+ 0 5+ 1 6+ 1
Global Growth 32 1+ 0 32+ 0 1+ 0 31+ 0 22+ 0 25+ 0
Global Growth & Income 7 0+ 1 7+ 0 0+ 0 6+ 0 6+ 0 6+ 2
Japan 5 2+ 0 5+ 0 0+ 1 4+ 0 1+ 0 1+ 0
UK Growth 21 1+ 3 21+ 0 0+ 0 20+ 0 18+ 3 17+ 2
UK Growth & Income 22 1+ 5 22+ 0 0+ 0 20+ 0 19+ 0 18+ 2
UK High Income 9 0+ 9 9+ 0 0+ 0 8+ 0 8+ 0 7+ 1
UK Small Companies 18 0+ 5 18+ 0 0+ 0 17+ 0 18+ 1 15+ 1
Others 84 4+ 18 84+ 0 1+ 5 81+ 0 37+ 3 49+ 2
All 218 9+ 43 218+ 0 2+ 6 207+ 0 139+ 9 150+ 11
Panel A of the table presents the estimations of the excess daily returns for a total of 218 UK investment trusts according to the aggregate and various fund styles for the augmented
T-M model under the OLS method, over the period July 1981 to June 2009. The t-statistics reported in parentheses are adjusted with the NeweyWest procedure. Auto (2) denotes the
Q-statistic for autocorrelation of the residuals at two lags. ARCH (1) denotes the modied F-statistic for residual ARCH effect at one lag. Panel B of the table shows the frequency count of
signicant coefcients for individual fund j, where the numbers represent the count of individual investment trusts in each fund style that have signicantly positive (+) or and negative
() values for various parameter estimates, at the 10% or less level of signicance.
a
b
c
1159
1160
Table 3b
OLS methods for the selectivity and timing performance for the augmented H-M model: July 1981 to June 2009.
Style N p p p p p p R2 AUTO (2) ARCH (1)
0.00012 (20.33)a (6.40)a (2.88)a (1.99)c 24.40a 523.36a
Asia Excluding Japan 12 (1.13) 0.4916 0.1148 (0.24) 0.0795 0.0266 0.0255 0.5180
Europe 8 0.00014 (0.98) 0.6505 (13.16)a 0.0905 (0.12) 0.1162 (4.65)a 0.0402 (2.52)b 0.0420 (3.47)a 0.2317 10.84a 8.75a
Global Growth 32 0.00005 (0.44) 0.4900 (24.07)a 0.1531 (0.40) 0.1076 (9.74)a 0.0412 (2.54)b 0.0457 (8.64)a 0.6264 20.88a 244.18a
Global Growth & Income 7 0.00003 (0.24) 0.2140 (8.10)a 0.1653 (0.41) 0.1202 (9.49)a 0.0189 (3.33)a 0.0163 (2.75)a 0.2413 15.55a 275.89a
Japan 5 0.00004 (0.32) 0.3664 (12.92)a 0.1903 (0.42) 0.2007 (12.59)a 0.0143 (2.06)b 0.0209 (2.53)b 0.4388 26.08a 123.19a
UK Growth 21 0.00021 (1.84)c 0.3468 (16.50)a 0.1562 (0.43) 0.1706 (11.94)a 0.0101 (2.80)a 0.0179 (2.73)a 0.4144 35.79a 123.56a
UK Growth & Income 22 0.00020 (1.57) 0.5043 (17.97)a 0.1258 (0.30) 0.0968 (8.03)a 0.0111 (2.51)b 0.0237 (3.77)a 0.5937 5.50a 90.56a
UK High Income 9 0.00056 (1.90)c 0.5351 (11.57)a 0.3362 (0.37) 0.1866 (7.48)a 0.0156 (3.01)a 0.0234 (2.02)b 0.2755 57.91a 154.29a
UK Small Companies 18 0.00040 (1.74)c 0.5159 (14.95)a 0.2159 (0.41) 0.1371 (7.82)a 0.0905 (3.40)a 0.0454 (5.89)a 0.4441 33.13a 331.31a
Others 84 0.00020 (1.22) 0.5090 (10.93)a 0.2069 (0.25) 0.1815 (8.79)a 0.0140 (2.82)a 0.0859 (5.35)a 0.4366 9.23a 55.32a
All 218 0.00018 (1.25) 0.4668 (20.37)a 0.1775 (0.42) 0.1473 (11.65)a 0.0364 (2.89)a 0.0647 (4.63)a 0.6011 24.67a 246.32a
Style N j =
/ 0 j =
/ 0 j =
/ 0 j =
/ 0 j =
/ 0 j =
/ 0
Asia Excluding Japan 12 0+ 0 12+ 0 0+ 0 12+ 0 5+ 1 6+ 0
Europe 8 0+ 0 8+ 0 0+ 0 8+ 0 5+ 1 5+ 0
Global Growth 32 1+ 1 32+ 0 1+ 0 30+ 0 23+ 0 25+ 0
Global Growth & Income 7 0+ 0 7+ 0 0+ 0 5+ 0 6+ 0 6+ 0
Japan 5 1+ 0 5+ 0 0+ 1 4+ 0 1+ 0 2+ 0
UK Growth 21 0+ 4 21+ 0 0+ 0 19+ 0 13+ 3 17+ 0
UK Growth & Income 22 0+ 4 22+ 0 0+ 0 20+ 0 15+ 0 12+ 0
UK High Income 9 0+ 2 9+ 0 0+ 0 8+ 0 18+ 0 5+ 0
UK Small Companies 18 3+ 3 18+ 0 0+ 0 17+ 0 17+ 1 15+ 0
Others 84 5+ 17 84+ 0 1+ 4 71+ 0 37+ 2 49+ 0
All 218 10+ 31 218+ 0 2+ 5 194+ 0 140+ 8 142+ 0
Panel A of the table presents the estimations of the excess daily returns for a total of 218 UK investment trusts according to the aggregate and various fund styles for the augmented
H-M model under the OLS method, over the period July 1981 to June 2009. The t-statistics reported in parentheses are adjusted with the NeweyWest procedure. Auto (2) denotes the
Q-statistic for autocorrelation of the residuals at two lags. ARCH (1) denotes the modied F-statistic for residual ARCH effect at one lag. Panel B of the table shows the frequency count of
signicant coefcients for individual fund j, where the numbers represent the count of individual investment trusts in each fund style that have signicantly positive (+) or and negative
() values for various parameter estimates, at the 10% or less level of signicance.
a
b
c
Table 4a
GJR-GARCH-M methods for the selectivity and timing performance for the augmented T-M model: July 1981 to June 2009.
Style N p p p p p p p GEDp R2 AUTO (2) ARCH (1)
Asia Excluding Japan 12 0.00031 (2.49)b 0.4749 (47.54)a 0.3084 (2.98)a 0.1134 (10.60)a 0.0137 (2.06)b 0.0017 (3.26)a 0.0003 (2.29)b 1.0538 (50.81)a 0.2486 11.59a 11.27a
Europe 8 0.00024 (1.37) 0.4459 (65.10)a 0.3316 (2.53)b 0.0882 (12.20)a 0.0328 (2.34)b 0.0089 (2.42)b 0.0007 (3.09)a 1.1055 (68.57)a 0.4125 0.14 0.20
Global Growth 32 0.00030 (2.39)b 0.5082 (58.35)a 0.2961 (2.42)b 0.0685 (14.87)a 0.0670 (3.10)a 0.0041 (1.82)c 0.0004 (0.91) 1.1735 (65.87)a 0.6189 5.40a 21.23a
Global Growth & Income 7 0.00026 (2.27)b 0.4901 (47.83)a 0.2287 (2.01)b 0.0424 (7.94)a 0.0319 (2.51)b 0.0070 (2.70)a 0.0005 (1.50) 1.1439 (59.96)a 0.5131 10.91a 14.49a
Japan 5 0.00024 (1.35) 0.5323 (43.25)a 0.1529 (1.64) 0.1034 (7.45)a 0.0815 (2.48)b 0.0022 (3.12)a 0.0005 (3.33)a 1.1683 (47.60)a 0.2226 3.74a 3.74a
UK Growth 21 0.00022 (0.89) 0.3018 (36.00)a 0.1990 (1.82)c 0.0803 (18.78)a 0.0915 (4.69)a 0.0010 (2.47)b 0.0004 (1.70)c 0.9185 (63.58)a 0.3704 15.08a 36.52a
UK Growth & Income 22 0.00016 (1.15) 0.4945 (52.74)a 0.2176 (2.00)b 0.0627 (12.46)a 0.1008 (4.29)a 0.0017 (2.70)a 0.0007 (1.75)c 1.1663 (82.94)a 0.5855 4.83a 5.36a
UK High Income 9 0.00015 (1.15) 0.2927 (30.17)a 0.1699 (1.77)c 0.0098 (24.25)a 0.0135 (3.92)a 0.0025 (2.88)a 0.0006 (0.87) 0.4735 (36.33)a 0.3345 11.21a 59.28a
UK Small Companies 18 0.00003 (0.52) 0.3398 (71.56)a 0.1894 (2.46)b 0.1031 (19.84)a 0.0581 (2.44)b 0.0057 (2.36)b 0.0003 (1.33) 0.9984 (54.03)a 0.4031 12.77a 33.59a
Others 84 0.00024 (1.53) 0.4842 (78.14)a 0.1093 (1.16) 0.1110 (16.62)a 0.0119 (1.85)c 0.0050 (2.99)a 0.0001 (0.60) 1.1397 (56.11)a 0.4237 9.26a 48.16a
All 218 0.00021 (1.31) 0.4760 (52.64)a 0.2350 (1.03) 0.0983 (20.34)a 0.0631 (2.76)a 0.0057 (2.38)b 0.0002 (1.67)c 1.1509 (66.84)a 0.5886 5.92a 26.66a
Style N j =/ 0 j =
/ 0 j =
/ 0 j =
/ 0 j =
/ 0 j =
/ 0 j =
/ 0 Reject GEDj 10%
Asia Excluding Japan 12 3+ 0 12+ 0 3+ 7 10+ 0 4+ 1 8+ 0 1+ 0 12+ 0
Europe 8 6+ 0 8+ 0 2+ 5 7+ 0 4+ 1 8+ 0 5+ 1 7+ 0
Global Growth 32 10+ 0 32+ 0 8+ 17 25+ 0 22+ 0 22+ 0 7+ 0 32+ 0
Global Growth & Income 7 3+ 0 7+ 0 3+ 2 7+ 1 4+ 0 6+ 0 3+ 0 7+ 0
Japan 5 1+ 0 5+ 0 1+ 3 4+ 0 3+ 0 3+ 0 4+ 1 5+ 0
UK Growth 21 3+ 4 21+ 0 11+ 1 17+ 0 15+ 0 13+ 2 12+ 0 20+ 0
UK Growth & Income 22 2+ 1 22+ 0 15+ 4 16+ 0 16+ 0 12+ 0 11+ 1 19+ 0
UK High Income 9 1+ 2 9+ 0 8+ 1 7+ 0 7+ 0 7+ 0 8+ 3 8+ 0
UK Small Companies 18 3+ 3 18+ 0 8+ 1 13+ 0 13+ 1 11+ 0 10+ 1 16+ 0
Others 84 7+ 8 84+ 0 29+ 18 78+ 0 64+ 0 49+ 10 18+ 5 83+ 0
All 218 39+ 18 218+ 0 88+ 59 184+ 1 152+ 2 139+ 12 79+ 12 209+ 0
Panel A of the table presents the estimations of the excess daily returns for a total of 218 UK investment trusts according to the aggregate and various fund styles for the augmented T-M
model under the GJR-GARCH-M method, over the period July 1981 to June 2009. Auto (2) denotes the Q-statistic for autocorrelation of the residuals at two lags. ARCH (1) denotes the
modied F-statistic for residual ARCH effect at one lag. The z-statistics are reported in parentheses. Panel B of the table shows the frequency count of signicant coefcients for individual
fund j, where the numbers represent the count of individual investment trusts in each fund style that have signicantly positive (+) or and negative () values for various parameter
estimates, at the 10% or less level of signicance.
a
b
c
1161
1162
Table 4b
GJR-GARCH-M methods for the selectivity and timing performance for the augmented H-M model: July 1981 to June 2009.
Asia Excluding Japan 12 0.00057 (3.21)a 0.4271 (24.09)a 0.0111 (0.87) 0.1162 (10.88)a 0.0170 (1.72)c 0.0017 (3.28)a 0.0002 (2.01)b 1.0376 (61.55)a 0.2421 11.75a 11.02a
Europe 8 0.00052 (2.71)a 0.3810 (30.01)a 0.0132 (1.40) 0.0876 (12.09)a 0.0283 (2.44)b 0.0089 (2.41)b 0.0007 (2.96)a 1.1029 (69.32)a 0.4062 0.14 0.17
Global Growth 32 0.00034 (2.54)b 0.4513 (57.66)a 0.0116 (2.10)b 0.0687 (14.88)a 0.0663 (3.08)a 0.0036 (2.39)b 0.0005 (1.14) 1.1698 (67.93)a 0.6167 5.55a 21.21a
Global Growth & Income 7 0.00044 (2.62)a 0.4403 (46.34)a 0.0103 (1.43) 0.0412 (7.68)a 0.0302 (2.37)b 0.0067 (2.60)a 0.0006 (1.74)c 1.1463 (62.01)a 0.5109 11.67a 15.21
Japan 5 0.00022 (1.10) 0.4775 (20.76)a 0.0126 (0.74) 0.1061 (7.59)a 0.0716 (3.27)a 0.0012 (2.05)b 0.0005 (3.26)a 1.1617 (52.45)a 0.2227 3.84a 3.74a
UK Growth 21 0.00015 (1.27) 0.2724 (35.60)a 0.0062 (1.03) 0.0806 (18.74)a 0.0942 (4.79)a 0.0011 (2.06)b 0.0004 (1.53) 0.9216 (63.84)a 0.3691 13.99a 36.36a
UK Growth & Income 22 0.00020 (1.37) 0.4332 (49.81)a 0.0119 (1.85)c 0.0621 (12.33)a 0.0994 (4.24)a 0.0020 (2.58)a 0.0008 (1.89)c 1.1565 (81.39)a 0.5825 4.71a 5.36a
UK High Income 9 0.00022 (1.13) 0.0899 (26.96)a 0.0068 (1.01) 0.0104 (10.77)a 0.0157 (1.94)c 0.0027 (3.88)a 0.0005 (0.41) 0.5145 (36.96)a 0.5800 11.91a 56.36a
UK Small Company 18 0.00004 (0.28) 0.2825 (31.76)a 0.0121 (1.80)c 0.1059 (20.21)a 0.0558 (2.33)b 0.0052 (3.23)a 0.0002 (0.76) 1.0008 (53.62)a 0.4025 12.25a 35.32a
Others 84 0.00027 (1.70)c 0.3967 (34.56)a 0.0167 (1.97)b 0.1126 (16.85)a 0.0126 (1.57) 0.0047 (2.86)a 0.0001 (0.60) 1.1214 (72.91)a 0.4148 9.36a 45.63a
All 218 0.00034 (1.80)c 0.4132 (50.18)a 0.0133 (2.18)b 0.0985 (20.32)a 0.0636 (2.79)a 0.0055 (3.46)a 0.0002 (1.66)c 1.1346 (75.20)a 0.5854 6.21a 23.82a
Style N j =/ 0 j =
/ 0 j =
/ 0 j =
/ 0 j =
/ 0 j =
/ 0 j =
/ 0 Reject GEDj 10%
Europe 8 5+ 0 8+ 0 0+ 7 8+ 0 4+ 0 5+ 0 4+ 0 8+ 0
Global Growth 32 20+ 0 32+ 0 0+ 19 28+ 0 24+ 0 24+ 0 7+ 0 32+ 0
Japan 5 4+ 0 5+ 0 0+ 4 3+ 0 2+ 0 3+ 0 3+ 0 5+ 0
UK Growth 21 8+ 0 21+ 0 0+ 9 20+ 0 16+ 0 15+ 0 12+ 0 21+ 0
UK Growth & Income 22 6+ 1 22+ 0 1+ 17 20+ 0 19+ 0 12+ 0 11+ 1 22+ 0
UK. High Income 9 2+ 0 9+ 0 4+ 4 5+ 0 7+ 2 8+ 1 6+ 0 9+ 0
Others 84 16+ 6 84+ 0 9+ 31 76+ 0 61+ 1 48+ 7 28+ 8 84+ 0
All 218 73+ 7 218+ 0 14+ 107 189+ 0 154+ 4 140+ 9 82+ 9 218+ 0
Panel A of the table presents the estimations of the excess daily returns for a total of 218 UK investment trusts according to the aggregate and various fund styles for the augmented H-M
a
b
c
timing coefcients. Specically, 88 (40.37%) individual funds exhibit signicantly positive timing abil-
ity, while 59 (27.06%) individual funds exhibit signicantly negative timing ability. The evidence that
the international fund styles underperform all other fund styles in respect of timing ability may reect
the greater level of asymmetry factors, such as the distance, limited risk sharing, among others, in the
international markets.
Table 4b further shows stronger evidence in support of the favourable selectivity ability for the
augmented H-M model compared with the results obtained for the augmented T-M model. For exam-
ple, the coefcient p for the aggregate portfolio shown in Panel A of Table 4b is signicantly positive
at the 10% level (t-stat = 1.80). Specically, 73 (33.49%) of 218 individual funds exhibit signicantly
positive selectivity ability, which is our strongest evidence in favour of selectivity ability under the GJR-
GARCH-M method. Furthermore, four international fund styles exhibit signicantly positive selectivity
ability, and we attribute the superior performance in respect of selectivity to the benets from the
internationally diversied portfolios and from the greater growth in stock returns in the international
markets.
However, the timing ability for the augmented H-M model shown in Table 4b is not as favourable
as that for the augmented T-M model shown in Table 4a, with a greater tendency towards negative
timing ability. Specically, for the augmented H-M model, 14 (6.42%) of 218 individual funds exhibit
signicantly positive timing, while 107 (49.08%) individual funds exhibit signicantly negative timing
ability. The inconsistent results for timing under the augmented H-M and T-M models might reect
the failure of the H-M model to capture the response of a fund manager under the changing market
conditions. Overall, compared with the results for both augmented T-M and H-M models under the
OLS method, the results under the GJR-GARCH-M method show substantially stronger evidence on
the selectivity and timing performance. For the aggregate portfolio, the coefcients for the selectivity
ability under both augmented models are consistently larger and more signicant under the GJR-
GARCH-M method than under the OLS method. As such, the GJR-GARCH-M method attributes more
credibility to the performance of investment trusts, on average, a third of funds exhibiting superior
selectivity ability and over a third of funds exhibiting superior timing ability. The superior performance
of the GJR-GARCH-M method holds, even when we estimate the basic T-M and H-M models.24 We
attribute the superior performance of the GJR-GARCH-M method over the OLS method to the ability
of the GJR-GARCH-M method in capturing both conditional volatility and asymmetry in the returns.
Therefore, we conclude that the GJR-GARCH-M method is more appropriate in evaluating the fund
performance, as it essentially accounts for the time-varying characteristics of factor loadings and
hence obtains more reliable results, in particular, when high frequency data, such as daily returns, is
used in the analysis.
3.3. GJR-GARCH-M conditional variance
In this section, we examine the parameter estimations of the conditional variance for both the
augmented T-M and H-M models. The results shown in Table 5 directly focus on the properties of
the conditional variance, where the conditional variance is obtained from the error terms in Eqs. (3)
and (4). That is, the results in Table 5 capture the properties of the conditional errors based on the
results of the mean equations in Tables 4a and 4b. In that context, the results in Table 5 give an
indication of the volatility associated with the mean excess returns in Tables 4a and 4b. This exam-
ination is important for several reasons. First, French et al. (1987) show that predicted volatility is
directly related to a stocks excess returns. In a GARCH framework, both volatility and asymmetry
(skewness) in returns are known to have direct effect on stock returns (Nelson, 1990). Asymmetric
volatility, in particular, reects the disproportionate effect that good and bad news can have the
leverage effecton future volatility and returns. Second, Ross (1989) suggests that volatility can be
considered as a measure of information ow. As such, both the conditional volatility and asymme-
try arising from the magnitude of the surprise or shock contained in news items would affect fund
24
The results based on the basic H-M and T-M models are not reported for the sake of brevity, but available on request.
1164
Table 5
GJR-GARCH-M methods for variance equation of augmented T-M and H-M models: July 1981 to June 2009.
Style N p p p
p R2 j =
/ 0 j =
/ 0 j =
/ 0
j =
/ 0
Panel A: GJR-GARCH-M methods for variance equation of the augmented T-M model
Asia Excluding Japan 12 0.0001 (6.81)a 0.1229 (9.53)a 0.0273 (1.87)c 0.8461 (77.93)a 0.2493 10+ 0 12+ 0 9+ 1 12+ 0
Europe 8 0.0001 (7.85)a 0.1152 (9.46)a 0.0248 (1.81)c 0.8345 (61.23)a 0.4131 6+ 0 7+ 0 2+ 1 7+ 0
Global Growth 32 0.0001 (7.53) a 0.0854 (8.47)a 0.0507 (4.03)a 0.8512 (76.35)a 0.6192 30+ 0 26+ 1 26+ 2 32+ 0
Global Growth & Income 7 0.0001 (6.15)a 0.0521 (7.69)a 0.0372 (4.16)a 0.9169 (136.82)a 0.5135 7+ 0 6+ 0 4+ 1 7+ 0
Japan 5 0.0001 (6.94)a 0.0960 (9.19)a 0.0656 (4.67)a 0.8473 (73.18)a 0.2233 3+ 0 4+ 0 3+ 0 5+ 0
UK Growth 21 0.0001 (7.06)a 0.0461 (6.96)a 0.0697 (6.65)a 0.8984 (115.73)a 0.3709 17+ 0 17+ 3 10+ 2 20+ 0
UK Growth & Income 22 0.0001 (8.10) a 0.0979 (7.93)a 0.0674 (4.43)a 0.8159 (58.23)a 0.5858 18+ 0 15+ 2 8+ 1 19+ 0
UK High Income 9 0.0001 (5.14)a 0.2932 (4.95)a 0.0303 (0.54) 0.7471 (27.93)a 0.0347 4+ 0 8+ 0 0+ 1 8+ 0
UK Small Companies 18 0.0001 (9.03)a 0.1901 (9.97)a 0.0160 (0.79) 0.7350 (41.71)a 0.4036 13+ 0 15+ 0 0+ 4 16+ 0
Others 84 0.0001 (6.85)a 0.0895 (9.03)a 0.0415 (3.70)a 0.8668 (92.72)a 0.4243 78+ 0 65+ 3 39+ 15 74+ 0
All 218 0.0001 (8.32) a 0.1122 (8.05)a 0.0574 (3.61)a 0.7973 (54.39)a 0.5889 186+ 0 175+ 9 101+ 28 200+ 0
Panel B: GJR-GARCH-M methods for variance equation of augmented H-M model

Asia Excluding Japan 12 0.0001 (6.89)a 0.1148 (8.97)a 0.0283 (1.98)b 0.8529 (77.53)a 0.2421 10+ 0 12+ 0 8+ 1 12+ 0
Europe 8 0.0001 (7.78)a 0.1152 (9.49)a 0.0236 (1.75)c 0.8348 (60.82)a 0.4062 7+ 0 7+ 0 4+ 0 8+ 0
Global Growth 32 0.0001 (7.44)a 0.0842 (8.38)a 0.0449 (3.68)a 0.8570 (78.05)a 0.6167 30+ 0 26+ 1 26+ 2 32+ 0
Japan 5 0.0001 (6.92)a 0.0947 (9.20)a 0.0633 (4.57)a 0.8495 (73.23)a 0.2227 3+ 0 4+ 0 5+ 0 5+ 0
UK Growth 21 0.0001 (7.15)a 0.0480 (7.02)a 0.0719 (6.63)a 0.8943 (111.57)a 0.3691 16+ 0 19+ 1 9+ 3 20+ 0
UK Growth & Income 22 0.0001 (8.09)a 0.0944 (7.66)a 0.0639 (4.30)a 0.8222 (59.08)a 0.5825 17+ 0 14+ 2 9+ 0 18+ 0
Others 84 0.0001 (6.80)a 0.0845 (8.57)a 0.0397 (3.69)a 0.8746 (100.24)a 0.4148 81+ 0 63+ 2 39+ 12 75+ 0
All 218 0.0001 (8.00)a 0.1043 (7.65)a 0.0492 (3.29)a 0.8133 (57.40)a 0.5854 188+ 0 173+ 6 100+ 27 200+ 0
Panels A and B of the table present the GJR-GARCH methods for variance equation of the augmented T-M and H-M models based on a total of 218 UK investment trusts according to fund
styles over the period 19812009. The z-statistics are shown in parentheses. The numbers on the right side of the table represent the frequency count of individual investment trusts in
each fund style that have signicantly positive (+) or and negative () values for various parameter estimates of the variance equation, at the 10% or less level of signicance.
a
b
c
returns. Finally, asymmetry and volatility represent important parameters that enable investors to
determine the risk associated with their portfolios when seeking to construct dynamic hedging strate-
gies and to estimate and predict value at risk (VaR). Thus, the magnitude of conditional asymmetry
and volatility in returns give an indication of the relative riskiness of returns when fund managers are
deemed to have selectivity and timing abilities. Recall that investors who hold investment trusts
are said to benet from the selectivity and timing skills of fund managers, so depending on the
level of volatility and asymmetry in fund returns, investors may require a risk premium for hold-
ing such portfolios. In this sense, it is important to assess the amount of conditional volatility and
asymmetry in the returns of investment trusts. Notice also that the parameter estimations are con-
ditional on the past price behaviour, that is, the GJR-GARCH-M method is able to capture the time
dependency in returns that is a signicant source of uncertainty, because both returns and risk can
change over time due to volatility clustering. Therefore, an assessment of the conditional variance pro-
vides an indication of the magnitude of volatility and down-side risks associated with the expected
returns.
Table 5 shows that the results of coefcients for the conditional variance for both augmented T-M
and H-M models are generally similar. For example, for the augmented T-M model, Panel A of Table 5
shows that the coefcients for the long run average conditional volatility (permanent component)
p for the aggregate portfolio and each fund style are all signicantly positive, consistent with the
necessary and sufcient conditions that the conditional variance needs to be positive. In addition,
the coefcients for past news p and the lagged conditional volatility
p are both signicantly pos-
itive for the aggregate portfolio and each fund style. The sum of p and
p is less than one, which
indicates that the conditional variance is a slow mean reverting process. That is, the impact of the
past volatility on fund returns does not die away quickly, suggesting a substantial risk to expected
returns. The coefcients for the conditional asymmetry p are also signicantly positive for all fund
styles expect for UK High Income and UK Small Companies, suggesting that negative shocks can have
a downward inuence on the expected returns and volatility in a substantial way. Panel A also reports
the number of individual funds with signicant coefcients under the variance equation. For exam-
ple, the coefcients of the permanent component j are signicantly positive for 186 (85.32%) of 218
individual funds, while the coefcients for past news j and the lagged conditional volatility
j are
signicantly positive for 175 (80.28%) and 200 (91.74%) individual funds, respectively, showing sig-
nicant asymmetric effects. In addition, for the conditional asymmetry j , 101 (46.33%) individual
funds exhibit signicantly positive asymmetry, suggesting that less than half of the funds are affected
by the leverage effect.
Overall, these results combined with favourable selectivity and timing performance suggest that
a reasonable proportion of investment trusts are able to avoid the negative inuences of condi-
tional volatility. Specically, international funds are more sensitive to the coefcients of variance
equations, irrespective of the augmented models. For example, over 90% of international funds are
sensitive to the coefcients of permanent component j , past news j , and lagged conditional volatil-
ity
j , while around 70% of domestic funds are sensitive to j , j , and
j . International funds are
also more sensitive to positive conditional asymmetry j than domestic funds, showing 41 of 59
(69.49%) international funds exhibit signicantly positive asymmetry, while only 18 of 70 (25.71%)
domestic funds exhibit signicantly positive asymmetry. On balance, it appears that the effects of
asymmetry and volatility are greater on the returns of international funds compared with the returns
of domestic funds, which may reect more severe information asymmetry when trading in foreign
stocks.
4. Robustness tests and discussions
In this section, we conduct various alternative in-sample and out-of-sample tests to examine the
robustness of the results shown in Section 3. Initially, we divide the whole sample period into two equal
sub-periods: 1 July 1981 to 30 June 1995 and 1 July 1995 to 30 June 2009, and then re-estimate the
coefcients for the selectivity and timing using the augmented T-M and H-M models under either the
OLS method or the GJR-GARCH-M method. The GJR-GARCH-M method results using both augmented
1166
Table 6a
GJR-GARCH-M methods for the selectivity and timing performance for the augmented T-M model: July 1995 to June 2009.
Panel A: Methods for the aggregate portfolio and fund styles
Asia Excluding Japan 12 0.00031 (2.42)b 0.5569 (40.75)a 0.3109 (2.27)b 0.1105 (8.00)a 0.0116 (1.81)c 0.0017 (2.56)a 0.0003 (1.61) 1.1824 (32.83)a 0.2969 11.93a 11.60a
Europe 8 0.00018 (1.49) 0.6242 (64.93)a 0.3983 (2.12)b 0.0529 (5.44)a 0.0196 (2.14)b 0.0028 (2.88)a 0.0009 (2.68)c 1.2928 (34.87)a 0.5485 0.15 0.20
Global Growth 32 0.00026 (1.96)b 0.4962 (87.88)a 0.2227 (2.00)b 0.0627 (10.81)a 0.0366 (2.58)b 0.0027 (1.94)c 0.0005 (0.73) 1.2900 (34.90)a 0.6601 5.56a 21.84a
Global Growth & Income 7 0.00022 (2.19)b 0.4253 (71.17)a 0.1150 (1.67)c 0.0358 (5.77)a 0.0184 (2.43)b 0.0054 (1.89)c 0.0003 (0.59) 1.1413 (39.50)a 0.5146 11.23a 14.91a
Japan 5 0.00015 (1.17) 0.6457 (35.65)a 0.2197 (1.67)c 0.0982 (5.03)a 0.0575 (2.63)b 0.0075 (2.00)b 0.0005 (2.18)b 1.3255 (32.97)a 0.2318 3.85a 3.85a
UK Growth 21 0.00022 (0.96) 0.3539 (63.32)a 0.2629 (1.74)c 0.0571 (10.01)a 0.0888 (3.49)a 0.0029 (2.16)b 0.0002 (0.41) 1.0742 (42.79)a 0.5104 15.51a 37.58a
UK Growth & Income 22 0.00010 (1.17) 0.4765 (76.45)a 0.2816 (1.95)c 0.0397 (6.07)a 0.1044 (3.12)a 0.0024 (2.38)b 0.0004 (0.66) 1.3311 (32.13)a 0.6054 4.97a 5.52a
UK High Income 9 0.00011 (1.17) 0.1943 (36.32)a 0.2466 (1.68)c 0.0519 (9.40)a 0.0123 (2.39)b 0.0064 (2.47)b 0.0009 (2.41)b 0.9442 (39.45)a 0.2659 11.53a 60.99a
UK Small Companies 18 0.00002 (0.42) 0.2694 (47.52)a 0.2266 (2.16)b 0.0860 (14.60)a 0.0312 (2.39)b 0.0084 (3.15)a 0.0002 (0.51) 0.9732 (37.05)a 0.3756 13.14a 34.56a
Others 84 0.00022 (1.49) 0.4819 (62.28)a 0.1577 (0.99) 0.1042 (13.12)a 0.0113 (2.23)b 0.0078 (1.99)b 0.0003 (0.67) 1.2642 (39.96)a 0.4996 9.53a 49.55a
All 218 0.00020 (1.19) 0.4828 (76.58)a 0.1414 (1.13) 0.0894 (14.10)a 0.0565 (1.94)c 0.0061 (1.99)b 0.0007 (1.25) 1.3112 (34.50)a 0.6017 6.10a 27.43a
Style N j =/ 0 j =
/ 0 j =
/ 0 j =
/ 0 j =
/ 0 j =
/ 0 j =
/ 0 Reject GEDj 10%
Europe 8 6+ 0 8+ 0 2+ 5 7+ 0 6+ 1 7+ 0 5+ 1 8+ 0
Global Growth 32 11+ 0 32+ 0 6+ 11 26+ 0 24+ 0 25+ 0 7+ 0 32+ 0
Japan 5 2+ 0 5+ 0 2+ 3 4+ 0 3+ 0 3+ 0 4+ 1 5+ 0
UK Growth 21 3+ 3 21+ 0 12+ 1 19+ 0 16+ 0 15+ 2 14+ 0 20+ 0
UK Growth & Income 22 2+ 1 22+ 0 15+ 2 18+ 0 17+ 0 14+ 0 13+ 1 21+ 0
UK High Income 9 2+ 1 9+ 0 6+ 1 7+ 0 7+ 0 7+ 1 8+ 3 8+ 0
Others 84 8+ 9 84+ 0 32+ 18 79+ 0 68+ 2 51+ 11 23+ 7 83+ 0
All 218 44+ 17 218+ 0 90+ 50 192+ 2 164+ 5 150+ 14 90+ 14 212+ 0
Panel A of the table presents the methods of the excess daily returns for a total of 218 UK investment trusts according to the aggregate and various fund styles for the augmented T-M
a
b
c
Table 6b
GJR-GARCH-M methods for the selectivity and timing performance for the augmented H-M model: July 1995 to June 2009.
Asia Excluding Japan 12 0.00053 (3.32)a 0.4605 (18.24)a 0.0201 (1.06) 0.1121 (8.11)a 0.0113 (1.78)c 0.0017 (2.70)a 0.0003 (1.89)c 1.1810 (33.04)a 0.2997 10.96a 10.65a
Europe 8 0.00055 (2.28)b 0.5097 (27.04)a 0.0231 (1.23) 0.0527 (5.42)a 0.0200 (2.19)b 0.0020 (2.03)b 0.0011 (3.00)a 1.2946 (34.89)a 0.5529 0.14 0.18
Global Growth 32 0.00034 (2.25)b 0.4360 (40.40)a 0.0122 (1.88)c 0.0629 (10.87)a 0.0393 (2.97)a 0.0024 (2.12)b 0.0007 (1.01) 1.2969 (35.10)a 0.6623 5.10a 20.06a
Global Growth & Income 7 0.00028 (1.82)c 0.3760 (32.69)a 0.0099 (1.40) 0.0346 (5.58)a 0.0266 (2.24)b 0.0048 (2.52)b 0.0005 (0.97) 1.1424 (39.68)a 0.5171 10.31a 13.70a
Japan 5 0.00015 (1.53) 0.5529 (16.58)a 0.0185 (0.73) 0.0947 (4.84)a 0.0438 (2.09)b 0.0066 (2.10)b 0.0005 (2.37)b 1.3247 (33.12)a 0.2328 3.54a 3.54a
UK Growth 21 0.00012 (1.32) 0.2914 (27.68)a 0.0120 (1.11) 0.0574 (10.04)a 0.0699 (2.73)a 0.0023 (2.14)b 0.0003 (0.63) 1.0760 (42.64)a 0.5091 14.25a 34.52a
UK Growth & Income 22 0.00018 (1.41) 0.4008 (33.09)a 0.0156 (1.72)c 0.0398 (6.05)a 0.0846 (2.89)a 0.0021 (2.11)b 0.0005 (0.78) 1.3409 (31.96)a 0.6069 4.57a 5.07a
UK High Income 9 0.00013 (1.15) 0.1284 (12.50)a 0.0139 (2.65)a 0.0567 (10.05)a 0.0139 (1.84)c 0.0062 (2.34)b 0.0006 (1.75)c 0.9687 (37.48)a 0.2586 10.60a 56.02a
UK Small Company 18 0.00004 (0.59) 0.1997 (18.67)a 0.0145 (1.75)c 0.0880 (14.77)a 0.0471 (2.68)a 0.0071 (2.64)a 0.0000 (0.14) 0.9818 (36.96)a 0.3737 12.07a 31.75a
Others 84 0.00029 (1.74)c 0.3811 (26.21)a 0.0200 (1.83)c 0.1035 (13.00)a 0.0104 (2.06)b 0.0070 (1.79)c 0.0003 (0.82) 1.2715 (40.20)a 0.5010 8.76a 45.51a
All 218 0.00027 (1.75)c 0.3958 (32.80)a 0.0178 (1.98)b 0.0897 (14.11)a 0.0576 (1.98)b 0.0056 (1.83)c 0.0007 (1.25) 1.3183 (34.52)a 0.6051 5.60a 25.20a
Style N j =/ 0 j =
/ 0 j =
/ 0 j =
/ 0 j =
/ 0 j =
/ 0 j =
/ 0 Reject GEDj 10%
Europe 8 6+ 0 8+ 0 0+ 7 8+ 0 4+ 0 5+ 0 4+ 0 8+ 0
Global Growth 32 23+ 0 32+ 0 1+ 21 25+ 0 23+ 1 27+ 0 7+ 0 32+ 0
Japan 5 4+ 0 5+ 0 0+ 3 3+ 0 2+ 0 3+ 0 3+ 0 5+ 0
UK Growth 21 8+ 0 21+ 0 0+ 9 19+ 0 16+ 0 15+ 0 11+ 1 21+ 0
UK Growth & Income 22 5+ 1 22+ 0 1+ 11 18+ 0 18+ 0 14+ 0 10+ 1 21+ 0
UK. High Income 9 2+ 0 9+ 0 4+ 4 5+ 0 7+ 2 8+ 1 6+ 0 9+ 0
Others 84 16+ 8 84+ 0 10+ 35 72+ 0 56+ 2 51+ 10 26+ 9 83+ 0
All 218 76+ 9 218+ 0 16+ 106 181+ 0 150+ 6 149+ 12 78+ 11 215+ 0
Panel A of the table presents the estimations of the excess daily returns for a total of 218 UK investment trusts according to the aggregate and various fund styles for the augmented H-M
a
b
c
1167
1168
Table 7
GJR-GARCH-M methods for variance equation of augmented T-M and H-M models: July 1995 to June 2009.
Style N p p p
p R2 j =
/ 0 j =
/ 0 j =
/ 0
j =
/ 0
Panel A: GJR-GARCH-M methods for variance equation of the augmented T-M model
Asia Excluding Japan 12 0.0001 (4.34)a 0.0949 (6.32)a 0.0506 (2.94)a 0.8739 (66.67)a 0.2981 11+ 0 12+ 0 9+ 1 12+ 0
Europe 8 0.0001 (4.36)a 0.0659 (5.62)a 0.0266 (2.11)b 0.9104 (91.84)a 0.5493 6+ 0 7+ 0 3+ 0 7+ 0
Japan 5 0.0001 (3.72)a 0.0698 (6.80)a 0.0424 (3.06)a 0.8987 (77.82)a 0.2331 3+ 0 4+ 0 3+ 0 6+ 0
UK Growth 21 0.0001 (5.74)a 0.0772 (5.19)a 0.0828 (4.27)a 0.8469 (54.48)a 0.5112 18+ 0 17+ 2 16+ 2 20+ 0
Others 84 0.0001 (5.09)a 0.0804 (5.67)a 0.0385 (2.77)a 0.8881 (77.03)a 0.5004 80+ 0 65+ 3 38+ 15 75+ 0
All 218 0.0001 (5.20)a 0.0851 (5.68)a 0.0405 (2.49)b 0.8748 (72.22)a 0.6024 189+ 0 177+ 8 123+ 25 200+ 0
Panel B: GJR-GARCH-M methods for variance equation of augmented H-M model

Asia Excluding Japan 12 0.0001 (4.30)a 0.0962 (6.34)a 0.0483 (2.81)a 0.8742 (66.78)a 0.3009 10+ 0 12+ 0 9+ 1 12+ 0
Europe 8 0.0001 (4.26)a 0.0643 (5.66)a 0.0235 (1.94)c 0.9140 (95.54)a 0.5537 7+ 0 7+ 0 4+ 0 8+ 0
Japan 5 0.0001 (3.72)a 0.0703 (6.87)a 0.0413 (2.99)a 0.8989 (78.28)a 0.2341 4+ 0 5+ 0 6+ 0 5+ 0
UK Growth 21 0.0001 (5.77)a 0.0735 (5.14)a 0.0816 (4.40)a 0.8512 (56.54)a 0.5099 17+ 0 19+ 1 15+ 1 20+ 0
UK High Income 9 0.0001 (5.64)a 0.1358 (6.52)a 0.0519 (2.21)b 0.7918 (37.81)a 0.2599 5+ 0 8+ 0 3+ 2 8+ 0
UK Small Companies 18 0.0001 (7.39)a 0.2260 (7.83)a 0.0554 (1.70)c 0.6987 (31.38)a 0.3748 14+ 0 15+ 0 5+ 6 16+ 0
Others 84 0.0001 (5.04)a 0.0815 (5.73)a 0.0383 (2.77)a 0.8874 (76.72)a 0.5019 81+ 0 64+ 3 41+ 11 77+ 0
All 218 0.0001 (5.14)a 0.0824 (5.59)a 0.0407 (2.58)a 0.8782 (74.26)a 0.6058 192+ 0 179+ 7 130+ 23 202+ 0
Panels A and B of the table present the GJR-GARCH methods for variance equation of the augmented T-M and H-M models based on a total of 218 UK investment trusts according to fund
styles over the period July 1995 to June 2009. The z-statistics are shown in parentheses. The numbers on the right side of the table represent the frequency count of individual investment
trusts in each fund style that have signicantly positive (+) or and negative () values for various parameter estimates of the variance equation, at the 10% or less level of signicance.
a
b
c
Table 8
Non-parametric approach for the timing performance: July 1981 to June 2009.

Style N Mean (%) Weighted average (%) >0 <0 % of at 10% % of at 10%
Asia Excluding Japan 12 2.266 (0.589) 2.493 (0.736) 0 2 0.00 8.33

Europe 8 1.225 (0.315) 1.103 (0.236) 1 2 0.00 12.50
Global Growth 32 1.053 (0.216) 1.316 (0.243) 1 4 3.13 6.25
Global Growth & Income 7 1.212 (0.274) 1.351 (0.343) 1 1 0.00 0.00
Japan 5 2.396 (0.493) 2.648 (0.616) 0 3 0.00 0.00
UK Growth 21 0.683 (0.156) 0.615 (0.117) 2 2 9.52 4.76
UK Growth & Income 22 0.289 (0.056) 0.246 (0.042) 2 2 4.55 4.55
UK High Income 9 2.133 (0.679) 2.666 (0.781) 2 1 11.11 0.00
UK Small Companies 18 0.450 (0.179) 0.517 (0.224) 0 3 5.56 5.56
Others 84 1.694 (0.387) 1.906 (0.484) 12 19 7.14 8.33
All 218 1.115 (0.296) 1.226 (0.333) 21 39 5.50 6.42
The table presents the results with the use of the non-parametric approach proposed by Jiang (2003) for the timing performance based on a total of 218 UK investment trusts according to

fund styles over the period July 1995 to June 2009. The details of the non-parametric approach are discussed in Jiang (2003). denotes the estimated market timing parameter. The third

column reports the equally weighted average , while the weighted average is reported in the fourth column, using weights that are inversely proportional to each estimates standard

error. Their standard errors are shown in the parenthesis. The fth (sixth) column shows the number of unit trusts that have above (below) zero. The seventh (eighth) column reports

the percentage of funds in each fund style that have above (below) zero at the 10% signicance level.
1169
0.0040 0.0025
0.0038 0.0023
0.0036 0.0021
0.0034 0.0019
0.0032 0.0017
0.0030 0.0015
Sep/09
Nov/09
Mar/10
Sep/10
May/10
Nov/10
Mar/11
May/11
Jul/09
Jul/10
Jan/10
Jan/11
Mar/10
May/10
Mar/11
May/11
Sep/09
Nov/09
Sep/10
Nov/10
Jul/09
Jul/10
Jan/10
Jan/11
a) Asia Excluding Japan b) Europe
0.0025 0.0020
0.0023 0.0018
0.0021 0.0016
0.0019 0.0014
0.0017 0.0012
0.0015 0.0010
Mar/10
May/10
Mar/11
May/11
Sep/09
Jan/10
Nov/09
Sep/10
Jan/11
Nov/10
Jul/09
Jul/10
Jan/11
Sep/09
Jan/10
Nov/09
Sep/10
Mar/10
May/10
Nov/10
Mar/11
May/11
Jul/09
Jul/10
c) Global Growth d) Global Growth & Income
Fig. 1. Plots of the coefcients i for four international fund styles (a) Asian Excluding Japan, (b) Europe, (c) Global Growth,
and (d) Global Growth & Income and their 95% condence bands based on recursive estimations of the augmented H-M model
over the successive 505-day sub-period from 1 July 2009 to 30 June 2011. , coefcient i ; . . .. . ., 95% condence bands.
T-M and H-M models over the second sub-period are reported in Tables 6a and 6b, respectively.25
Overall, our previous important ndings based on the whole time period some strong evidence on
favourable selectivity and timing performance under the GJR-GARCH-M method are also observed
during both sub-periods. For example, for the augmented T-M model, 90 (41.28%) of 218 funds exhibit
signicantly positive timing ability compared with 88 (40.37%) funds for the whole time period. Sim-
ilarly, for the augmented H-M model, 76 (34.86%) of 218 funds exhibit signicantly positive selective
ability compared with 73 (33.49%) funds for the whole time period. The results presented in Table 7
for the variance equations for the sub-period are not qualitatively different from those reported in
Table 5.
In addition, we examine the out-of-sample timing and selectivity performance of UK investment
trusts over the subsequent period 1 July 2009 to 30 June 2011 for each of the 218 investment trusts.26
This procedure consists of estimating the augmented T-M or H-M model under the GJR-GARCH-M
method in a two-year window (505 trading days) from 1 July 2009 to 30 June 2011. That is, we run an
in-sample forecasting regression using data from 1 July 1995 to 30 June 2009 and make a forecast for
1 July 2009. Then a new observation is added while the rst one is dropped, i.e., we update the sample
period to include observations from 2 July 1995 to 1 July 2009 and then make a forecast for 2 July
2009, and so forth. We continue this process until we generate forecasts for all of the 505 successive
days, ending in 30 June 2011. We focus exclusively on the evolution of the coefcients i and
i over
time, as they have critical implications for the selectivity and timing ability, respectively.
25
The results under the GJR-GARCH-M method over the rst sub-period 1 July 1981 to 30 June 1995 are materially unchanged.
Also, we nd little evidence on the selectivity and timing ability for investment trusts under the OLS method over both sub-
periods, irrespective of the model used. These results are not reported for the sake of brevity, but available on request.
26
We thank an anonymous referee for suggesting the use of the out-of-sample test. We plot all gures for 218 individual
investment trusts and for all fund styles, which are not fully presented for the sake of brevity, but available on request.
0.0030 0.0030
0.0027 0.0027
0.0024 0.0024
0.0021 0.0021
0.0018 0.0018
0.0015 0.0015
Mar/10
May/10
Mar/11
May/11
Sep/09
Nov/09
Sep/10
Nov/10
Jul/09
Jul/10
Jan/10
Jan/11
Jul/09
Jul/10
Sep/09
Jan/10
Sep/10
Jan/11
Nov/09
Mar/10
May/10
Nov/10
Mar/11
May/11
a) UK Growth b) UK Growth & Income
0.0030 0.00030
0.0027 0.00027
0.0024 0.00024
0.0021 0.00021
0.0018 0.00018
0.0015 0.00015
Mar/10
May/10
Mar/11
May/11
Jul/09
Jul/10
Jan/10
Sep/09
Sep/10
Jan/11
Nov/09
Nov/10
May/10
May/11
Mar/10
Mar/11
Jul/09
Jul/10
Sep/09
Jan/10
Sep/10
Jan/11
Nov/09
Nov/10
c) UK High Income d) UK Small Companies
Fig. 2. Plots of the coefcients i for four domestic fund styles (a) UK Growth, (b) UK Growth & Income, (c) UK High Income, and (d) UK Small Companies and their 95% condence
bands based on recursive estimations of the augmented T-M model over the successive 505-day sub-period from 1 July 2009 to 30 June 2011. , coefcient i ; . . .. . ., 95% condence
bands.
1171
Our previous important nding that international fund styles exhibit favourable selectivity ability
and domestic fund styles exhibit favourable timing ability still holds. For example, Fig. 1 illustrates
the recursively estimated parameters of i and their 95% condence bands for four international fund
styles (e.g., Asia Excluding Japan, Europe, Global Growth, and Global Growth & Income), using the
augmented H-M model, while Fig. 2 illustrates the recursively estimated parameters i and their 95%
condence bands for four domestic fund styles (e.g., UK Growth, UK Growth & Income, UK High Income,
and UK Small Company). Overall, the recursive coefcient estimations for both selectivity and timing
abilities are well within their 95% condence bands, suggesting that there is little uncertainty about
the forecast errors and that our out-of-sample results show no discrepancy from previous in-sample
results.
Finally, some recent studies have been attracted to the use of simulations to provide insights into the
selectivity and timing abilities of fund managers. Jiang (2003), in particular, develops a non-parametric
approach to test market timing ability. Jiang (2003) argues that the non-parametric approach does not
rely on the statistical distribution of returns, but more on the quality of the fund managers timing
signal, as opposed to the aggressiveness of his/her response. We, therefore, apply the non-parametric
approach to test the market timing ability of UK investment trusts. Following Jiang (2003), we denote
the estimated market timing parameter with . 27 We compute the average market timing based
on both equal weighting and standard error weighting,28 the number of funds that have positive and
negative , and the number of funds with signicantly positive or negative at the 10% level, for
the aggregate portfolio and various fund styles. Overall, Table 8 shows no evidence of superior market
timing ability of UK investment trusts. The average value of all investment trusts is 1.12%, suggesting
that the probability that the fund manager moves the funds exposure to the market in the correct
direction is 1.12% lower than the probability of a move in the wrong direction. The total numbers
of funds with positive and negative values are 21 (9.63%) and 39 (17.89%) out of 218 individual
funds, respectively, while only 12 (5.50%) and 14 (6.42%) individual funds exhibit signicantly positive
and negative value, respectively, at the 10% level. All fund styles show up negative average timing
coefcients except for the fund style of UK High Income. This slightly perverse market timing ability is
in line with empirical results based on the non-parametric approach (see, e.g., Jiang, 2003; Cuthbertson
et al., 2008) and those based on the OLS method (see, e.g., Ferson and Schadt, 1996; Goetzmann et al.,
2000). What seems to be common here with the use of both the non-parametric approach and the
OLS method is their failure to explicitly model and capture the stylised behaviour of returns, such as
conditional volatility and asymmetry. We view this as a weakness of these studies and we should also
note that conditional estimations for the timing and selectivity performance tend to perform better
than unconditional estimations, even without the use of GARCH-M method. These are the grounds
under which Ferson and Schadt (1996) appear to have obtained better estimations for timing and
selectivity performance.
5. Conclusions
This study examines the selectivity and timing performance of UK investment trusts over the period
July 1981 to June 2009, using both T-M and H-M models augmented with size, value, and momen-
tum factors under the OLS method adjusted with the NeweyWest procedure and the GJR-GARCH-M
method. To our knowledge, this is the rst study that employs the asymmetry GJR-GARCH-M method
to evaluate the selectivity and timing performance of UK investment trusts. Our results suggest that the
27
Details of the non-parametric approach are discussed is in Jiang (2003) and Cuthbertson et al. (2010b). Jiang (2003) states
the following properties of the non-parametric test, i.e., rst, it is easy to implement; second, the t-statistic is not affected by
the managers risk aversion; third, the test is more robust to various information and incentive structures, as well as to timing
frequencies and underlying distributions; and nally, the method is readily applicable to analyse the market timing ability of
nancial advisors or newsletters (Graham and Harvey, 1996), or the timing behaviour of individual investors (Odean, 1998;
Barber and Odean, 2000). Cuthbertson et al. (2010b) compare the parametric and non-parametric methods used in evaluating
the performance of mutual funds and present a number of advantages of the non-parametric methodology over the widely
used T-M and H-M models.
28
The standard error weighting assigns a weight to each unit trusts that is inversely proportional to its standard error.
choice of estimation methods has a substantial impact on the selectivity and timing performance. The
OLS method generates very little support for the selectivity and timing ability, while the GJR-GARCH-M
method reverses the results. The number of individual funds that show favourable selectivity and tim-
ing ability under the GJR-GARCH-M method increases substantially. For example, 88 (40.37%) out of
218 individual funds exhibit signicantly positive timing ability for the T-M model, while 73 (33.49%)
individual funds exhibit signicantly positive selectivity ability for the augmented H-M model. We
attribute the superior performance of the GJR-GARCH-M method to the ability of this approach to
explicitly model time variation in returns.
In addition, the selectivity and timing performance under the GJR-GARCH-M method varies by fund
styles. In particular, the international fund styles exhibit stronger selectivity ability than other domes-
tic fund styles. We attribute this to the benets of holding the internationally diversied portfolios.
In contrast, domestic fund styles outperform all other funds in respect of timing ability. This nding
might be explained by the more severe information asymmetry in the international market, making
it more difcult for UK fund managers to accurately predict the market movement and to adjust their
portfolio holdings accordingly. Our results are robust to various in-sample and out-of-sample tests and
have valuable implications for practitioners in making their asset allocation decisions across different
fund styles.
Acknowledgements
We wish to thank Ian M. Dobbs, the editor (G. Geoffrey Booth), and specially an anonymous reviewer
for helpful comments and suggestions on this paper.
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