International Journal of Managerial Finance

Evaluation of Malaysian mutual funds in the maximum drawdown risk measure

framework
Mohammad Reza Tavakoli Baghdadabad Paskalis Glabadanidis

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Evaluation of Malaysian mutual

funds in the maximum drawdown
risk measure framework
Mohammad Reza Tavakoli Baghdadabad
Graduate School of Business, National University of Malaysia, Bangi,
Malaysia, and

Paskalis Glabadanidis
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Business School, University of Adelaide, Adelaide, Australia

Evaluation of
Malaysian
mutual funds
247
Received 26 July 2011
Revised 9 January 2012
17 July 2012
19 November 2012
30 November 2012
Accepted 1 December 2012

Abstract
Purpose This paper aims to evaluate the risk-adjusted performance of the management styles of
Malaysian mutual funds using nine modified performance evaluation measures generated by the
maximum drawdown risk measure (M-DRM) based on the modern portfolio theory. The purpose is to
report the findings in a manner which is realizable by the average investors and portfolio managers.
Design/methodology/approach This paper evaluates the performance of more than 400
Malaysian mutual funds using risk-adjusted returns over the two sub-periods of 2000-2005 and
2006-2011. The M-DRM, as a different measure from downside risk, is applied to improve nine
risk-adjusted performance measures of Sortino, Treynor, M-squared, Jensens alpha, information ratio
(IR), MSR, upside partial ration (UPR), FPI, and leverage factor. It proposes a new single-factor model
to test the maximum drawdown beta and alpha in the M-DRM framework.
Findings The evidence clearly indicates that the replacement framework in terms of MDB, the
maximum drawdown beta, and the maximum drawdown CAPM can be replaced by the conventional
frameworks in terms of MVB, beta, and the CAPM and also MSB, downside beta, and D-CAPM
for modifying nine performance evaluation measures from the management styles of Malaysian
mutual funds.
Practical implications The research evidence reported in this paper can be applied as input in the
process of decision making by small and average investors and portfolio managers who are seeking
the possibility of participating in the global stock market through mutual funds.
Originality/value This paper is the first study to estimate a new regression model in the M-DRM
framework to evaluate the performance of Malaysian mutual funds. In addition, it proposes nine
modified performance evaluation measures in the M-DRM framework for the first time.
Keywords Maximum drawdown risk measure (M-DRM), Maximum drawdown beta, Downside risk,
Semi-variance, Mutual fund, Malaysia, Unit trusts, Financial risk
Paper type Research paper

1. Introduction
Due to the primary studies of Treynor (1965), Jensen (1968), and the subsequent studies
of Sortino and Price (1994), Modigliani and Modigliani (1997), Sortino et al. (1999),
Pedersen and Rudholm (2003), and Ferruz and Sarto (2004), the performance
measurement of a managed portfolio has attracted remarkable interest in the economic
and financial literature. From a general view, two vital approaches may be recognized
and followed for performance measurement. The first approach considers the returns
of managed portfolios, and its purpose is to define and interpret the conventional
reward-to-risk measures under symmetric conditions. The second approach investigates
the returns of the managed portfolios and concentrates on utilizing and introducing the
measures which make it possible to infer the choices made by investment managers
under asymmetric conditions.

International Journal of Managerial

Finance
Vol. 9 No. 3, 2013
pp. 247-270
r Emerald Group Publishing Limited
1743-9132
DOI 10.1108/IJMF-07-2011-0056

IJMF
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248

The first approach has empirically concentrated on the performance evaluation

of managed portfolios in the domestic fund markets (i.e. Carhart, 1997; Baer et al., 2006;
Afza and Rauf, 2009), and international fund markets (i.e. Eun et al., 1991; Droms and
Walker, 1994; Bauer et al., 2005) in the mean-variance (MV) framework. However, the
first approach is an inappropriate method of performance evaluation for two reasons:
first, it is only a desirable approach when the returns have a symmetric distribution,
and, second, it can only be employed as a risk measure when the distribution of returns
is normal. Furthermore, both the symmetry and the normality of portfolio returns
are seriously questioned by the empirical evidence on the issue (i.e. Arditti, 1971;
Simkowitz and Beedles, 1978; Chunhachinda et al., 1997).
Again, the second approach extends alternative frameworks in responding to the
requirements of the market asymmetric condition. In this context, this study extends
a recently proposed approach in the mean-maximum drawdown framework as
maximum drawdown risk (M-DRM) measure. This risk measure has been extended
to evaluate the investment portfolios. It is less used to evaluate the performance of
different types of funds. Unlike the downside risk, M-DRM evaluates the loss from a
local maximum to the next local minimum and is intuitively appealing for institutional
investors (Hamelink and Hoesli, 2003).
The drawdown of returns is a more acceptable measure of risk for several reasons:
first, investors logically prefer a risk measure as down-side volatility (i.e. Nantell and
Price, 1979; Stevenson, 2001; Galagedera, 2007). Second, unlike the downside risk,
M-DRM evaluates the loss from a local maximum to the next local minimum and is
intuitively appealing for institutional investors (Hamelink and Hoesli, 2003). Third, the
maximum drawdown risk is more beneficial than the variance (standard deviation)
when the dispersion of returns is asymmetric and just as beneficial when the
dispersion is symmetric; accordingly the maximum drawdown risk is a better risk
measure in comparison with the variance. Finally, the maximum drawdown risk
combines into one measure the information generated by three statistics, variance,
semi-variance, and skewness, thus, making it possible to utilize a single-factor model
to estimate the expected returns.
This study proposes a replacement risk measure for fund managers and diversified
investors, the maximum drawdown b (MD-b), and also an alternative pricing model in
the M-DRM framework to estimate maximum drawdown a (MD-a). It also extends the
maximum drawdown risk concepts upon seven risk-adjusted measures of Sortino,
M2, information ratio (IR), MSR, FPI, UPR, and leverage factor, and then runs a singlefactor regression model based on the M-DRM to estimate the MD-b and the MD-a and
modify two other measures of Treynor and Jensens a over the management styles of
Malaysian mutual funds. After extending the risk-adjusted measures in the M-DRM
framework and testing the maximum drawdown single-factor regression model,
we evaluate the performance of mutual funds using data from the management styles
of Malaysian mutual fund market for two separated sub-periods from 2000 to 2005 and
2006 to 2011.
The evidence described supports the M-DRM upon the conventional risk measures,
and, in particular, the MD-b. The empirical evidence also indicates that mean returns
are much more sensitive to differences in MD-b than to equal differences in
conventional b. Moreover, this study modifies nine measures of Sortino, Treynor, M2,
Jensens a, IR, MSR, UPR, FPI, and leverage factor. Finally, this paper questions the
conventional framework in terms of MVB, b, CAPM, and also mean-semi variance
behavior (MSB), downside b, and D-CAPM, and suggests replacing them with the

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replacement framework in terms of mean-maximum drawdown behavior (MDB), the

MD-b, and the maximum drawdown CAPM.
The paper is structured as follows. In Section 2, the MVB, MSB, and MDB
framework are reviewed. In Section 3, empirical evidence is described. Finally, a
summary and conclusion is considered in Section 4.

Evaluation of
Malaysian
mutual funds

2. MVB vs MDB framework

We first explain the conventional MVB and MSB framework, their relevant pricing
model (CAPM), and also the risk-adjusted measures associated with the MVB. Then we
elaborate the proposed approach of this paper as the MDB framework along with its
relevant proposed pricing model and also its modified risk-adjusted measures.
Then we briefly explain how to estimate the MD-b (MD-b) to replace the conventional
and downside b, and, finally, we propose new risk-adjusted measure in terms of the
M-DRM to evaluate the performance of Malaysian mutual funds.

249

2.1 MVB, asset pricing, and traditional measures

The conventional MVB framework explains that an investors utility (U) is
theoretically determined by the mean (mP) and variance (sP) of returns associated
with the investors portfolio, where U is defined as U U(mP , sP). In such a framework,
the risk of a certain fund i is measured by the funds standard deviation (SD) of returns
(si), which is mathematically defined by Equation (1):
q
1
si ERi  mi 2 
where R and m are returns and mean returns, respectively. However, when security i is
just one out of many in a completely-diversified portfolio, its risk is computed by its
covariance with respect to the market portfolio (sim), which is mathematically defined
by Equation (2):
sim ERi  mi Rm  mm 

where m is defined as the market portfolio. Interpretation of the covariance is not

straightforward, as the statistic is both unbounded and scale-dependent. A more
beneficial measure of risk can be computed by dividing this statistic by the output of
fund is SD of returns and the market portfolios standard deviation, thus, getting fund
is correlation with respect to the market index (rim) as follows:
rim

sim
ERi  mi Rm  mm 

q
si :sm
ERi  mi 2   ERm  mm 2 

Alternatively, the covariance between fund i and the market index can be divided by
the variance of market index, thus, getting fund is b (bi) as follows:
bi

sim ERi  mi Rm  mm 

s2m
ERm  mm 2

This risk measure is directly applied in the model most widely utilized to estimate the
expected returns on fund, the CAPM, as given by Equation (5):
ERi Rf bi Rm  Rf

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250

where E(Ri), Rf and Rm denote the expected return on fund i, the risk-free rate, and the
required return on the market, respectively.
The CAPM can be run by an ex-post regression model to estimate a as a
performance important measure as given by Equation (6):
a fERi  Rf bi Rm  Rf g

Variance and its relevant SD are only an appropriate risk measure if the returns
dispersion is symmetric. The MVB approach is only valid under symmetry conditions.
The MVB approach was gradually considered as a basis for introducing the
risk-adjusted measures. These measures have been empirically pioneered by Treynor
(1965), Jensen (1968), Sortino and Price (1994), Modigliani and Modigliani (1997),
Sortino et al. (1999), Pedersen and Rudholm (2003), and Ferruz and Sarto (2004). The
statistical techniques extended by them are the most commonly applied portfolio
performance measures using variance even now. First, Treynor (1965), using the
CAPM as a benchmark, adjusted the excess return by the funds b. Then, Jensen (1968)
proposed the measure, namely, a coefficient, which explains the difference between the
actual excess return and the expected excess return, as described by Equation (6).
Consequently, Sortino and Price (1994) proposed a new performance measure to
calculate each of the funds through dividing the mean excess return by the total risk of
the fund. This measure is particularly attractive in an international setting because it
does not depend directly on the market portfolio. To improve the prior measures,
Modigliani and Modigliani (1997) suggested the performance measure of M2, which
multiplies the Sharpe measure by the benchmark SD and then adds the risk free rate of
return to that. They also proposed the leverage factor through dividing the market SD
by the funds SD. Subsequently, Sortino et al. (1999) proposed the upside potential
ratio (UPR) as the probability-weighted average of returns above the free risk rate.
In addition, Pedersen and Rudholm (2003) suggested the IR as a measure similar to the
Sharpe measure, except the numerator is the total instead of the excess of returns.
They also suggested another performance index, namely, firms performance index to
compare the Sharpe measure and median Sharpe measure. Finally, Ferruz and Sarto
(2004) suggested a revised ratio of Sharpe measure for bear markets through replacing
the relative return premium instead of the difference rirf.
However, there have been several reasons to select the aforementioned performance
evaluation measures. The major motivation for using Sortino and FPI measure is that
they allow a direct comparison of the risk-adjusted returns of any mutual funds,
regardless of their correlations with a benchmark. Moreover, Sortinos measure
considers the total market risk, which can provide a better understanding of the overall
investment performance of a fund (i.e. Roy, 1952; Du, 2008). The reason for utilizing
the M2 and leverage factor is that they are intuitively quite appealing for investors.
The idea that underlies the methodology of these measures is to adjust the returns of a
mutual fund to the level of risk in an unmanaged stock market index and then evaluate
the returns on the risk-matched fund. These two measures have two distinct
advantages over earlier techniques. First, they report the risk-adjusted performance of
a mutual fund as a percentage, which is easily understood by a lay investor. Second,
they permit investors to calculate the degree of leverage that is needed to attain the
highest return possible for a given level of risk (Modigliani and Modigliani, 1997;
Arugaslan et al., 2008). IR is also similar to the Sortino ratio. However, since the Sortino
measure is the excess return of an asset over the return of a risk free asset divided by

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the variability or SD of returns, the IR is the active return to the most relevant
benchmark index divided by the SD of the active return or tracking error that:
estimates ex-post value added and relates this to ex-ante opportunity available in the
future, and describes the opportunities accessible to the active manager (Sortino and
Price, 1994; Pedersen and Rudholm, 2003). For MSR, This new measure provides
consistent rankings for any set of portfolios (Ferruz and Sarto, 2004). Finally, the
UPR ratio is an appropriate measure to rank portfolio performance based on a
combination of the upside potential and the measures under asymmetric conditions
like downside risk.
2.2 MSB and asset pricing
P2
In the MSB
P2 framework, the utility of a certain investor is given by U U(mD, D),
where
D describes the downside variance of funds (semi-variance of funds).
P
Accordingly, the risk of a fund i is computed by the funds downside SD of returns ( i),
which is given by:
X q
EfminRi  mi ; 02 g
7
i

Equation (7) is, in other words, aP

particular case of the semi-SD that can be expressed
with respect to market index B( Bi) as:

X q
EfminRi  B; 02 g
8
Bi

P
This paper will denote the semi-SD of fund i simply as i. In a framework of downside
risk, the counterpart of
Pfund is covariance to the market portfolio is resulted by its
downside covariance ( iM), which is defined by Equation (9):
X
EfminRi  mi ; 0  minRM  mM ; 0g
9
iM

Moreover, the co semi-variance is unbounded, but it can also be standardized by

dividing it by the output of fund is SD of returns and the markets SD of returns,
accordingly, obtaining the fund is downside correlation (YiM) as follows:
P
iM
YiM P P
i:
M
10
EfminRi  mi ; 0  minRM  mM ; 0g
q
EfminRi  mi ; 02 g  EfminRM  mM ; 02 g
Alternatively, the co semi-SD can be divided by the markets semi-variance of returns,
accordingly obtaining fund is downside b (bi) as follows:
P
EfminRit  mit ; 0  minRMt  mMt ; 0g
D
11
bi PiM

2
EfminRMt  mMt ; 02 g
M
P P
The downside b, which is alternatively defined as bi ( i/ M)YiM, can be described
into a CAPM-like model in the downside risk framework (D-CAPM). Such a model, as
the one suggested in this paper, is defined by Equation (12):
ERi Rf bDi :Rm  Rf

12

Evaluation of
Malaysian
mutual funds
251

IJMF
9,3

252

2.3 MDB, asset pricing, and the proposed measures

P
In the replacement
MDB framework, the investors utility is defined by U U(mP , 2P),
P2
where P denotes the maximum drawdown risk of returns on the investors portfolio.
In this context, the risk of a certain fund i is individually measured by the funds
downside SD of a combination of loss from a local maximum to the next local minimum
and risk premium as given by Equation (13):

X q
EfminDt1 Rit  mit ; 02 g
13

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where D0 is equal to 0, Dt denotes the maximum loss that an investor suffers from 0 to t.
Equation (13) is, in fact, a special case of the semi-deviation,
P which can be more
generally expressed with respect to any benchmark return B( Bi) as follows:
X q
EfminDt1 Rit  B; 02 g
14
Bi

P
This paper will denote the M-DRM of fund i simply as i. In M-DRM framework, the
counterpart of fund is covariance
to the market portfolio is resulted by its M-DRM
P
covariance, or co M-DRM ( iM) for short, which is given by Equation (15):
X
EfminDt1 Rit  mit ; 0
iM
15
 minDt1 RMt  mMt ; 0g
The co M-DRM is unbounded, but it can also be standardized by dividing it by the
output of fund is M-DRM of returns and the markets M-DRM of returns, hence,
obtaining fund is M-DRM correlation (YiM) as follows:
P
iM
YiM P P

i
M
16
EfminDt1 Rit  mit ; 0  minDt1 RMt  mMt ; 0g
q
EfminDt1 Rit  mit ; 02 g  EfminDt1 RMt  mMt ; 02 g
Alternatively, the co M-DRM can be divided by the markets M-DRM of returns,
accordingly obtaining fund is M-DRM b (bMDRM
) as follows:
i
P
DRM
bM
PiM
i
2
M

EfminDt1 Rit  mit ; 0  minDt1 RMt  mMt ; 0g

17

EfminDt1 RMt  mMt ; 02 g

P P
( i/ M)YiM, can be
This M-DRM b, which is alternatively defined as bMDRM
i
described into a CAPM-like model in the M-DRM framework. Such a model, as the one
suggested in this paper, is given by Equation (18):
DRM
 Rm  Rf
ERi Rf bM
i

18

As observed by a direct comparison of the two Equations (5) and (12), the proposed
model replaces the b of the CAPM and bD of the D-CAPM by the M-DRM b, the

appropriate measure of systematic risk in the M-DRM framework. This replacement is

the most important contribution of this study.
To estimate MD-b and a, as main contribution of this study, the ex-posed maximum
drawdown CAPM model is given by Equation (19):

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yt l0 l1  xt et ;

19

and a is to test
where the appropriate method to compute and estimate bMDRM
i
a linear regression between the independent variable xt min[(Dt1 (RMtmMt), 0)]
and the dependent variable yt min[(Dt1 (Ritmit), 0)], which obtain the
and a as the slope of the regression model and a constant by Equation (19),
bMDRM
i
where bD
i l1 and a l0.
2.3.1 A brief discussion on the M-DRM b. The M-DRM b of any fund i given by
Equation (17) can be computed and estimated in at least three ways: first, through
dividing the co M-DRM between fund i and the market index given by Equation (15)
through the M-DRM
the market index given by Equation (13) for i M;
P of P
( iM/ 2M) Moreover, this coefficient can be computed and
that is bMDRM
i
estimated by multiplying the ratio of M-DRM of fund i and the market index, the
former given by Equation (13) and the next given by Equation (13) for i M, by the
M-DRM correlation
between fund i and the market index, given by Equation (16); that
P P
( i/ M)YiM. Both described
methods are mathematically
similar
is, bMDRM
i
P P P
P P
MDRM
2

/(

);
hence,
b

/
because
of
the
fact
which
Y
iM
iM
i
M
i
iM
M)
P2 P P
P P
i
M  YiM/
M (
i/
M)YiM.
Finally, the M-DRM b of any fund i can be computed by regression analysis.
Let yt min[(Dt1 (Ritmit), 0)] and xt min[(Dt1 (RMtmMt), 0)], and let my and mx
be the mean of yt and the mean of xt, respectively. If a regression model is run by yt as
the dependent variable and xt as the independent variable (i.e., yt l0 l1  xt et,
where e is an error term and l0 and l1 are coefficients to be estimated), the estimate of
l1 would be given by Equation (20):
l1

Ext  mx yt  my 
Ext  mx 2 

20

Alternatively, as defined in Equation (17), bMDRM

can be computed by Equation (21):
i
DRM
bM

Ext  yt 
Ex2t 

Evaluation of
Malaysian
mutual funds

21

In fact, the appropriate method to compute and estimate bMDRM

using the regression
i
model is to test a linear regression without considering a constant between the
independent variable xt min[(Dt1 (RMtmMt), 0)] and the dependent variable
yt min[(Dt1 (Ritmit), 0)], which obtain the MD-b as the slope of the regression
l1. This is as one of the most important
model as yt l1  xt et, where bMDRM
i
contributions of this paper.
2.3.2 The proposed measures in the M-DRM framework. As another contribution,
this study modifies nine conventional risk-adjusted measures of Sortino, M2, IR, MSR,
UPR, FPI, and leverage factor in which the M-DRM of any fund and market index are
first computed to directly insert in the measures. Then, the single-factor regression
model in the M-DRM framework, as described in the aforementioned section, is

253

IJMF
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proposed to estimate the MD-b and the MD-a for modifying two other measures of
Treynor, and Jensens a. The considered measures are modified as follows:
(1)

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254

The modified Sortino measure

This study inserts the M-DRM computed by Equation (13) into the conventional
Sortino measure to propose a new measure, namely, the modified Sortino
measure (SD
i ):
Ri
SiD P

22
i

P
where Ri and i are the mean excess return (RiRf) and the M-DRM of fund
return i, respectively.
(2) The modified M2 measure
This study inserts the M-DRM computed by Equation (13) into the traditional
M2 measure to propose a new measure, namely, the modified M2 measure (MD
i ):
R i  Rf X
Rf
23
MiD P
m
i

P
To compute the M-DRM of market index ( m), this study proposes Equation (24):
q
X

EfminDt1 Rmt  mmt ; 02 g

24
m
where D0 is equal to 0. Given the sample observations for Xm, t t 0, 1, y, T, the
maximum drawdown Dt(Xm, t) or simply Dt represents the maximum loss of
market index from 0 to t.
(3) The modified leverage factor
This study inserts the M-DRM computed by Equations (13) and (24) into the
traditional leverage factor to propose a new measure, namely, the modified
leverage factor (LD
i ):
P
D
Li Pm
25
i

As the modified leverage factor is greater than one it implies that the M-DRM
of the fund is less than the M-DRM of the market index. Therefore, investors
should consider levering the fund by borrowing money and investing in that
particular fund.
As the leverage factor is lower than one it implies that the M-DRM of the
fund is greater than the M-DRM of the market index. Therefore, investors
should consider un-levering the fund by selling out part of their holding in the
fund and investing the proceeds in a risk-free security, such as a Treasury bills.
(4) The modified Treynor measure
The modified Treynor is computed by Equation (26):
TiD

Ri  Rf
bDi

where the MD-b is estimated by Equation (19).

26

(5)

The modified Jensens a measure

As described in Section (2.3), this paper estimates MD-a to propose the
modified Jensens a measure by Equation (27):

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y t l0 x t l1 e

27

where yt is defined as the dependent variable, yt min[(Dt1 (Ritmit), 0)], xt

is as the independent variable, xt min[(Dt1 (RMtmMt), 0)], which obtains
the MD-b as the slope of the regression model as yt l1  xt et, where
l1 and a l0.
bMDRM
i
(6) The modified IR
This study improves the ratio proposed by Pedersen and Rudholm (2003) using
Equation (13) by embedding the M-DRM instead of the conventional SD, and
proposes a new measure, namely, the modified IR (IRD):
rP
28
IRD P
i

(7)

The modified MSR

This study extends the index proposed by Ferruz and Sarto (2004) by
embedding the M-DRM into Equation (13) to propose a new measure, namely,
the modified MSR index (MSRD
i ):
ri =rf
MSRiD P

29

(8)

The modified funds performance index

This study extends the index proposed by Pedersen and Rudholm (2003) on
mutual funds and utilizes Equation (13) to propose a new measure, namely, the
modified funds performance index (FPID):
FPI D

SRD
100
MSRD

30

where SRD and MSRD are the modified Sharpe ratio and median modified
Sharpe ratio, respectively.
(9) The modified UPR
This study extends the index proposed by Sortino et al. (1999) on mutual funds
and uses Equation (13) to propose a new ratio, namely, the modified upside
potential ratio (UPRD):
PT
T1 ri  rf
D
UPRi t1 P
31
i

2.4 The evidence of M-DRM

The majority of the previous performance measures are based on a risk measure,
which evaluates the overall risk of an asset. However, the risk measurement may
follow alternative approaches (i.e. Biglova et al., 2004; Ortobelli et al., 2005;
Rachev et al., 2008) like the M-DRM.

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256

The M-DRM concept, which is theoretically different with downside risk, was first
introduced by Grossman and Zhou (1993), and Dacorogna et al. (2001). They
investigated two risk-adjusted performance measures for investors with risk-averse
preferences in the Sharpe measure and the maximum drawdown framework.
Their measures were more robust vs clustering of losses and had the considerable
ability to fully characterize the dynamic behavior of investment strategies. Chekhlov
et al. (2000, 2005) proposed a risk measure, namely, drawdown-at-risk, which included
the maximum drawdown and average drawdown as its limiting cases to evaluate
the managed portfolios. They first showed that the portfolio allocation problem is
efficiently solved by the DRM-based risk measures and then reported that the real-life
asset-allocation problem is improved using these measures. Krokhmal et al. (2001) and
then Steiner (2011) compared risk management methodologies to optimize a portfolio
of hedge funds based on the risk measures of conditional value-at-risk and conditional
drawdown-at-risk. They found that a considerable advantage of the DRM-based risk
measures is to implement robust and efficient portfolio allocation algorithms which
can successfully manage optimization problems with thousands of instruments and
scenarios. In an interesting study, Hamelink and Hoesli (2003) investigated the role of
real estate in a mixed-asset portfolio when the maximum drawdown is utilized instead
of the SD. They showed that the maximum drawdown concept is one of the most
natural measures of risk, and that such a framework can help reconcile the optimal
allocations to real securities and the effective allocations by institutional investors.
They found that most portfolios optimized by return-DRM in comparison with MV
portfolios get a much lower maximum drawdown and a slightly higher SD.
Their optimal allocations in the form of DRM measures had much more efficient in
comparison with the MV-based allocations. Alexander and Alexandre (2006) using a
maximum drawdown constraint, provided a characteristic of optimal portfolios in the
MV framework. Gilli and Schumann (2009) investigated alternative specifications like
partial and conditional moment, quantile, and maximum drawdown as risk replacement
measures to analyze the empirical performance of portfolios. Their findings showed
that these DRM-based alternative risk and performance measures in many cases are
better than the MV approaches. Caporin and Lisi (2009) extended the M-DRM concepts
by enlarging the set of analyzed measures in the framework of this risk measure.
They showed that when the number of assets is larger than the sample dimension, the
MV approaches cannot be useful and should use the alternative DRM-based approach.
Kim (2010) studied the circumstances, in which the M-DRM is related to a rational
investors choice of an investment portfolio. He showed that an investor facing extreme
uncertainty makes a choice based on M-DRM. Finally, Schuhmacher and Eling (2011)
asserted that M-DRM theoretically is as good as the Sharpe measure and can be
replaced with the MV approach.
However, it can be concluded that previous studies apply the M-DRM in optimizing
the MV and its relevant portfolios. To date, none of the studies extend the concepts of
these risk measures on the risk-adjusted performance evaluation measures, such as
those used in this paper.
3. Empirical evidence and data
3.1 Data
This study utilizes the monthly data of different categorizes of Malaysian mutual
funds. The data are extracted from the database of Bloomberg and considers all of the
funds that have an investment objective concentrated on mutual funds. The research

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sample excludes mutual funds: which are invested in specific sectors, which have a
performance guarantee, which have a limited duration, and which have continuous
operation without stopping during the research period. The research population
includes the monthly returns adjusted by dividend from more than 700 Malaysian
mutual funds for the 11-year period from first month of 2000 to the third month of 2011.
We decompose the research time period based on two sub-periods 2000 to 2005 as the
Out-sample and 2006 to 2011 as the In-sample to consider more samples for analysis.
These detached sub-periods help to consider dead funds in each of the sub-classes and
reduce the limitations related to survivorship bias. Another reason of the selection of
the sub-periods is that, we consider one of the largest equity busts in the Malaysia
fund market during the financial crisis 2007-2008; it means that we compare the
performance of mutual funds during a period almost without crisis (2000-2005)
and a period under crisis (2006-2011). In such a framework, this paper considers 91
out-sample funds and 359 in-sample funds based on sub-classes of management styles.
The monthly return data for the 90-day Treasury bills as free risk rate, and
the Malaysian MSCI index and the Malaysian Standard and Poors (S&P) index as
benchmark indexes, and also the Kuala Lumpur Composite Index (KLCI), as market
index, are extracted from the Bloomberg database.

Evaluation of
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mutual funds
257

3.2 Survivorship bias

A feature in investigating many mutual funds is related to the comparison between the
performance evaluation of surviving and non-surviving mutual funds with evidence
that the surviving mutual funds outperform the non-surveying funds. The evidence of
Elton et al. (1996) indicated that survivorship bias is larger in the small mutual funds
than in the large mutual funds, as the small mutual funds having a high probability of
folding. They determine the size of the survivorship bias for the US mutual funds
industry as about 0.9 percent per annum, where the survivorship bias is defined and
evaluated as average a for the surviving funds minus average a for the non-surviving
funds (The a is defined as the risk-adjusted return over the S&P 500).
In this study, 91 of the mutual funds out of sample (or 20 percent from the research
population) and 359 of the in-sample funds (or 50 percent from the research population)
are investigated as the research sample. Again, the long-run time period of 2000-2011 is
considered to minimize the impact of survivorship bias and generalize the sample
result to statistical population of this study. Table I reports the results of computing
the average a of the sub-sets of the surviving and non-surviving mutual funds.

Out-sample between 2000 and 2005

Survivors
Non-survivors
Difference
In-sample between 2006 and 2011
Survivors
Non-survivors
Difference

Number of funds

Average a

91
639

0.276585
0.102416
0.174169

359
371

0.216452
0.121031
0.095421

Note: This shows a comparison of average a between surviving and non-surviving mutual funds at
the statistical significance level of 5 percent

Table I.
The descriptive result
of survivorship bias

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258

Surprisingly, this study finds that the sub-group of the surviving funds outperforms
the group of the non-surveying funds during the research period, as reported by
a positive and significant average a of 0.276585 for the out-sample funds and a of
0.216452 for in-sample funds (see Elton et al., 1996). For the non-surviving funds, the
average as are 0.102416 and 0.121031 for out-sample and in-sample funds, respectively,
which display low statistical significance. The differences between the average as for
survivors and non-survivors are 0.174169 and 0.095421 for out-sample and in-sample
funds, respectively.
Table I shows a comparison of average a between surviving and non-surviving
mutual funds at the statistical significance level of 5 percent.
3.3 Normality test
Since the maximum drawdown risk measure is usually used under the asymmetric
condition, this paper investigates whether the majority of the research sample follows
an asymmetric distribution. In this context, Table II shows that all of the management
styles of the out-sample funds have positive skewness, while all of the in-sample funds
styles have a negative skewness except the market neutral style. The results of the
kurtosis also indicate that six styles have leptokurtic distributions, while five styles
have a platikurtic distribution for out-sample funds. The kurtosis for in-sample
styles reports that two styles have leptokurtic distributions and other nine styles have
a platikurtic distribution.
The results of the Jarque-Bera ( JB) test detects that the hypothesis of the normality
of returns dispersion is not accepted for nine out-sample styles while the other two outsample styles show normal return dispersions at the significant level of 5 percent. The
results of JB for in-sample styles show that all of the styles are rejected at the 5 percent
level. Moreover, the results reveal that the Malaysian benchmark indexes are
asymmetrical on the left and they have a leptokurtic distribution. The JB statistic
represents that the hypothesis of the normality of returns distribution for the Malaysia
benchmark indexes, S&P, KLCI, and MSCI, are not normally distributed over the
out-sample styles, except MSCI index at the 1 percent level. In addition, the JB test of
benchmark indexes are not normally distributed over the in-sample styles, except the
KLCI index at the 1 percent level. Thus, the asymmetrical nature of the research
sample confirms the fact that portfolio returns are not, in general, normally distributed
(i.e. Arditti, 1971; Simkowitz and Beedles, 1978; Chunhachinda et al., 1997).
Accordingly, the asymmetric returns of the considered funds actually reinforce the
benefits of this study.
3.4 Empirical results
The second step of the investigation consists of calculating the out-sample and
in-sample periods for each of the considered styles. One statistic, which summarizes
the M-DRM performance of each style, and another risk statistic that summarizes the
risk measures under each of the aforementioned definitions are reported in Table III.
The six considered risk measures are two for the conventional MVB framework
(the conventional SD and b), two for the MSB framework (the semi-deviation and bD ),
and two for the alternative MDB framework (the M-DRM and bMDRM ). The evidence
of Table III reports that the null hypothesis for all of the out-sample styles is rejected
at the significant level of 5 percent. Moreover, the last row of the panels A and B of the
table reports the M-DRM of KLCI index with the numerical values of 0.156 and 0.126,
respectively. The average of the b, downside b, and M-DRM values for the in-sample

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Management styles

No.
funds

Mean
return

Panel A: Out-sample (2000-2005)

Blend
12
1.36e-16
Contrarian
10
1.27e-16
Emerging markets
12
7.12e-17
Equity income
8
1.46e-16
Geographically
focused
14
2.26e-17
Growth
6
1.16e-16
Growth and income
8
1.17e-16
Index fund
7
2.14e-17
Long-short
6
7.14e-17
Market neutral
4
2.32e-17
Value
5
7.48e-17
KLCI index

0.004286
MSCI index

0.000285
S&P index

0.004542
Panel B: In-sample (2006-2011)
Blend
69
4.83e-17
Contrarian
59
2.42e-17
Emerging markets
42
7.48e-17
Equity income
30
9.31e-17
Geographically
focused
35
3.31e-17
Growth
40
9.40e-17
Growth and income
41
1.26e-16
Index fund
15
3.58e-17
Long-short
10
4.70e-17
Market neutral
9
4.23e-17
Value
9
1.51e-18
KLCI index

0.009928
MSCI index

0.007570
S&P index

0.010953

Jarque-Bera
Kurtosis
( JB)

p-value

1.860808
6.793252
2.130430
3.770618

3.857065
75.59429
2.057575
6.481348

0.145361
0.000000
0.357440
0.039138

0.060368
0.546678 3.344721
0.081047
0.053030 2.207792
0.066136
0.638754 3.466558
0.095624
0.260904 2.230611
0.056022
0.502335 3.061397
0.082442
0.181464 2.062873
0.064537
0.281942 2.814631
0.057887
0.209327 4.372040
0.050806 0.460383 4.358167
0.061938
0.161278 2.693170

3.340407
1.623724
4.701326
2.196617
2.575039
2.566892
0.895496
5.230148
6.843250
0.503726

0.188209
0.444030
0.095306
0.333435
0.275954
0.277081
0.639066
0.073162
0.032659
0.777351

0.098246
0.042559
0.055803
0.064392

0.264090
0.136949
0.163198
0.101275

2.220180
2.133586
1.662179
1.759895

2.291658
2.133041
4.898772
4.078794

0.317960
0.344204
0.086347
0.130107

0.106848
0.102578
0.113552
0.072490
0.078684
0.054885
0.041068
0.050623
0.067862
0.046707

0.237102
0.117450
0.155535
0.082933
0.444390
0.174913
0.222468
0.612932
0.560985
0.315015

1.670775
1.750245
1.723548
1.978322
2.701098
2.874666
2.802542
4.064030
3.410854
3.359708

5.145249
4.177420
4.459073
2.767621
2.271448
0.356726
0.612140
6.806832
3.688016
1.359677

0.076335
0.123847
0.107578
0.250622
0.321189
0.836639
0.736335
0.033259
0.158182
0.506699

SD

0.078893
0.037001
0.031928
0.070509

Skewness

0.234401
1.959162
0.115527
0.699319

Notes: The Jarque-Bera ( JB) is estimated as JB N [s2/6 (k3)2/24], where s, k, N are the value of
skewness, the value of kurtosis, and the number of data applied for the test, respectively. The JB test
uses a w2-distribution with two degrees of freedom

periods is larger than the out-sample periods which shows the financial crisis impact
over the period. In addition, the higher magnitude of the drawdown risk of KLCI index
for the in-sample periods is also another reason for undesirable effects of the crisis on
the risk levels. Another remarkable finding is that the DRM risk for the out-sample
period is lower than two other risk measures, except three sub-classes, while this risk
for the in-sample periods is larger than others. It may be because the M-DRM usually
considers the loss maximum to compute the risk, thus when computing this risk under
crisis condition (which usually faces more loss), the risk levels show higher magnitude.
It implies that the M-DRMs in the crisis condition are more compatible to aggressive
(risk-loving) investors.
A correlation matrix concerning six risk measures is reported in Table IV and
explains a significant correlation in more detail. As reported in panels A and B of the

Evaluation of
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mutual funds
259

Table II.
Descriptive statistics
of normality test

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260

Table III.
The results of computed
risk measure

Management styles

M-DRM

Panel A: Out-sample (2000-2005)

Blend
0.101
Contrarian
0.065
Emerging markets
0.069
Equity income
0.121
Geographically focused
0.113
Growth
0.113
Growth and income
0.114
Index fund
0.122
Long-short
0.114
Market neutral
0.110
Value
0.114
Average
0.11
Drawdown risk of KLCI index
Panel B: In-sample (2006-2011)
Blend
0.051
Contrarian
0.043
Emerging markets
0.060
Equity income
0.068
Geographically focused
0.086
Growth
0.094
Growth and income
0.102
Index fund
0.132
Long-short
0.117
Market neutral
0.214
Value
0.118
Average
0.10
Drawdown risk of KLCI index

^D
b

^M DRM
Statistics of the b
^M DRM t-statistic R2 p-value
b

SD

DR

^
b

0.033
0.029
0.028
0.042
0.041
0.037
0.044
0.043
0.040
0.041
0.043
0.04

0.029
0.028
0.027
0.035
0.035
0.031
0.036
0.034
0.034
0.034
0.035
0.03

0.50
0.25
0.35
0.61
0.65
0.58
0.64
0.63
0.63
0.50
0.64
0.54

0.47
0.28
0.23
0.13
0.34
0.23
0.48
0.47
0.63
0.58
0.62
0.43
0.61
0.51
0.60
0.70
0.67
0.80
0.56
0.89
0.63
0.96
0.53
0.54
0.126

10.90
5.93
14.01
25.59
28.24
10.93
21.29
32.05
27.37
10.95
70.68

0.82
0.68
0.75
0.65
0.48
0.53
0.48
0.70
0.67
0.33
0.92

0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000

0.025
0.026
0.027
0.027
0.031
0.031
0.034
0.042
0.035
0.075
0.049
0.04

0.024
0.026
0.026
0.026
0.026
0.026
0.028
0.032
0.030
0.050
0.041
0.03

0.64
0.19
0.34
0.58
0.53
0.86
0.63
0.57
0.61
0.56
0.68
0.56

0.59
0.50
0.21
0.83
0.36
0.84
0.52
0.67
0.55
0.86
0.83
0.91
0.63
0.89
0.62
1.11
0.59
0.91
0.58
0.95
0.65
0.84
0.56
0.85
0.156

9.44
123.19
101.25
11.52
87.11
8.34
101.06
2.14
49.29
50.12
41.26

0.90
0.87
0.85
0.81
0.89
0.97
0.92
0.97
0.89
0.90
0.86

0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.032
0.000
0.000
0.000

Notes: M-DRM, Maximum drawdown risk; SD, standard deviation; DR, downside risk;
^ conventional b; b
^D , downside b; b
^M DRM , the b estimated by the M-DRM
b,

table, the drawdown risk measures (the M-DRM and the drawdown b) outperform the
conventional risk measures (the SD, b, and downside risks).
To compare the risk measures, Figure 1 displays the risks dispersion generated by
the M-DRM, the conventional SD, and the downside risk.
The theoretical quantile-quantile (QQ) plot is utilized to investigate whether the
data in a single series follow a specified theoretical distribution; e.g. whether the data
are normally distributed (Chambers et al., 1983; Cleveland, 1994). Figure 1 displays that
the M-DRM has a closer distribution than two other risk measures to the QQ plot,
which shows this statistic has a better data distribution in comparison with others.
More specifically, detailed analysis concerning the relationship between risk and
expected return across funds can be concluded by regression analysis. This study runs
a cross-sectional simple linear regression model to investigate the relationship between
mean returns with each of the six considered risk variables. Equation (32) is run for
this mean:
MRi g0 g1 RMi ui

32

SD

Panel A: Out-sample (2000-2005)

MEAN
1
SD
0.75
1
SEMI
0.95
0.91
M-DRM
0.21
0.06
b
0.19
0.09
D-b
0.26
0.19
DD-b
0.03
0.12
Panel B: In-sample (2006-2011)
MEAN
1
SD
0.83
1
SEMI
0.96
0.95
M-DRM
0.05
0.09
b
0.03
0.01
D-b
0.60
0.59
DD-b
0.12
0.07

SEMI

DRM

1
0.16
0.16
0.24
0.07

1
0.53
0.19
0.05

1
0.32
0

1
0.32

1
0.06
0.02
0.63
0.09

1
0.10
0.15
0.13

1
0.04
0.02

1
0.07

D-b

DD-b

Optimized
Drawward Risk

Standard Deviation

0.2
0.0

0.2
0.0 0.2 0.4 0.6 0.8
Quantiles of SD

0.60

0.8

0.55

0.6
0.4
0.2
0.0

0.2
0.0 0.2 0.4 0.6 0.8 1.0
Quantiles of OD

0.50
0.45
0.40
0.35
0.
40
0.
45
0.
50
0.
55
0.
60
0.
65
0.
70

0.4

Table IV.
Correlation matrix
of full sample

Downside Risk

1.0
Quantiles of Normal

Quantiles of Normal

0.6

Evaluation of
Malaysian
mutual funds
261

Notes: M-DRM, maximum drawdown risk; SD, standard deviation; SEMI, downside risk
(semi-standard deviation; b, conventional systematic risk; D-b, downside systematic risk; DD-b,
maximum drawdown risk systematic

Quantiles of Normal

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MEAN

Quantiles of DSD

where MRi, RMi, g0, g1, ui, and i are mean return, risk measure, a constant, regression
coefficient, an error term, and funds (styles), respectively. The regression results of the
six models (one for each of the six considered risk measures) are reported in panels A
and B of Table V.
Panel A displays the result of OLS linear regressions out of sample and panel B also
displays the results of OLS regressions for the in-sample styles. The evidence shows
the same results in both panels, in which all six considered risk measures are explicitly
significant due to differentiation in their explanatory power. In addition, Table V
detects that M-DRM outperforms the conventional SD and semi-SD (D-SD) due to its

Figure 1.
Volatility around
quantiles of normal

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262

MV

g0

MRi g0 g1RMi ui,

t-statistics
g1
t-statistics

Panel A: Out-sample (2000-2005)

SD
0.040
45.43
b
0.0002
0.36
D-SD
0.031
62.67
bD
0.004
7.08
M-DRM
0.020
12.19
bMDRM
0.036
11.38
Panel B: In-sample (2006-2011)
SD
0.018
0.58
b
0.010
3.51
D-SD
0.021
0.68
D
b
0.022
8.01
M-DRM
0.025
4.21
bMDRM
0.033
10.26

R2

Adj-R2

1.06
0.22
11.18
0.121
0.11
0.051

54.42
1.81
84.66
15.55
12.66
11.37

0.34
0.0005
0.46
0.041
0.59
0.62

0.34
0.0004
0.46
0.041
0.58
0.61

0.59
0.11
0.27
0.102
0.14
0.064

7.68
4.81
4.17
12.55
6.29
10.21

0.36
0.14
0.10
0.19
0.47
0.54

0.35
0.14
0.10
0.18
0.47
0.53

Table V.
Notes: MR, mean return; SD, conventional standard deviation; b, conventional b; D-SD, semi-standard
Simple regression analysis deviation; bD, downside b; M-DRM, maximum drawdown risk measure; bMDRM, maximum
upon full sample
drawdown b

explanatory power. The significant coefficient of the M-DRM and its relevant b in the
out-sample funds is greater than the other risk measures. This superiority can also
be found in the in-sample funds, where two measures of M-DRM and its relevant b
have significant coefficients equivalent to 0.47 and 0.53, respectively. These values are
greater than the conventional measures, which implicate the superiority of the two
proposed measures, the M-DRM and its b, in comparison with the conventional ones.
3.5 Funds rank using the modified measures
As a brief conclusion at this point, the results discussed and reported reveal two
considerable findings in which, when comparing the M-DRM and MD-b with the
conventional SD and b, the M-DRM outperforms the conventional SD and also
semi-SD; the risk measure that best describes the relationship between the expected
return and market return is the MD-b.
Panel A of Table VI reports details of the rank for the whole sample, in which nine
conventional measures are modified using the M-DRM to compare and rank each of the
mutual funds together with respect to the two benchmark indexes of Malaysian S&P
and MSCI. The highest modified Sortino measure for the whole sample belongs to
Contrarian with the numerical value of 8.61. The evidence shows that the ranking of
five measures of Treynor, M2, IR, MSR, and FPI is also similar to the rank of Sortino
measure in which Contrarian dominates the other styles. The highest numerical value
of the modified Jensens a measure over the whole sample is associated with the market
neutral style with a numerical value of 0.36. Among the management styles of mutual
funds, the rank of S&P index over the whole sample of the modified measures is 13th
for four measures of Treynor, M2, IR, and FPI, while the rank for the two measures
of Sortino and MSR is 12th, and for the Jensens a and URP measures is fourth and
ninth, respectively. Among the management styles of mutual funds, the rank of MSCI
index over the sample of the modified measures is 11th for three measures of Treynor,
M2, and URP, while the rank for other five measures is 13th, 12th, and second.

Sortino

Panel A: Whole sample (2000-2011)

Contrarian
8.61
Index fund
6.00
Emerging markets
4.59
Growth
4.44
Blend
3.85
Equity income
2.89
Market neutral
2.79
Value
2.18
Growth and income
2.12
Long-short
2.01
Geographically focused
1.55
S&P index
1.32
MSCI index
1.31
Panel B: Out-sample (2000-2005)
Contrarian
4.26
Index fund
3.23
Emerging markets
3.21
Growth
3.12
Blend
3.09
Equity income
3.01
Market neutral
2.72
Value
2.66
Growth and income
2.50
Long-short
2.37

Management styles

1.44
1.00
0.32
0.70
0.71
0.62
0.59
0.27
0.51
0.41
0.33
0.26
0.30
0.86
0.66
0.65
0.64
0.63
0.61
0.56
0.54
0.51
0.49

5.63
0.93
2.15
1.50
2.44
1.19
0.70
0.52
0.97
0.59

M2

3.12
1.43
0.71
0.75
0.70
0.54
0.67
0.35
2.18
1.13
1.00
0.23
0.42

Treynor

9.03
6.34
3.82
5.27
4.06
4.00
4.98
1.35
2.22
1.51
1.32
1.10
1.25
4.42
3.36
3.39
3.25
3.21
3.15
2.84
2.80
2.64
2.50

0.02
0.02
0.00
0.05
0.08
2.12
0.36
0.00
0.28
0.05
0.04
0.05
0.13
0.15
0.05
0.23
0.12
0.23
0.09
0.06
0.01
0.09
0.02

165.12
125.71
126.62
121.45
120.01
117.65
106.15
104.50
98.58
93.53

316.46
225.13
105.21
186.72
166.45
132.94
130.99
93.21
104.94
80.81
61.51
51.30
50.93
156.50
118.64
118.01
114.56
113.47
110.32
100.00
97.48
91.87
86.98

213.83
134.67
123.55
115.68
101.30
92.37
101.81
72.00
77.50
73.91
47.74
45.76
48.45

Measures in the maximum drawdown risk framework

Jensens a
IR
MSR
FPI

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0.01
0.04
0.01
0.03
0.02
0.03
0.03
0.04
0.04
0.03

0.00
0.01
0.03
0.03
0.04
0.03
0.04
0.02
0.04
0.04
0.04
0.03
0.02

URP

(continued)

1.14
0.97
1.27
0.95
0.88
1.05
0.85
1.03
0.99
0.98

1.04
1.17
0.94
0.83
0.89
0.88
0.87
0.87
0.78
0.85
1.02
1.01
0.75

Leverage factor

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Table VI.
Rank of the modified
measures in the M-DRM
framework

Table VI.
Sortino

Geographically focused
2.25
S&P index
1.71
MSCI index
1.25
Panel C: In-sample (2006-2011)
Contrarian
18.96
S&P index
11.47
Emerging markets
10.80
Geographically focused
8.62
Growth and income
7.19
Long-short
5.40
MSCI index
5.11
Index fund
4.34
Blend
3.14
Growth
1.70
Equity income
0.26
Market neutral
0.05
Value
0.00

Management styles
0.47
0.36
0.27
2.42
1.48
1.39
1.12
0.94
0.71
0.67
0.58
0.43
0.24
0.06
0.04
0.03

1.00
1.45
0.78
0.88
0.83
0.69
0.65
0.46
2.11
0.79
0.99
0.33
0.04

M2

0.81
0.33
0.24

Treynor

0.18
0.03
0.17
0.22
0.05
5.61
0.01
0.97
0.36
0.01
0.18
0.37
0.12

0.11
0.02
0.02
19.64
11.78
11.28
8.95
7.48
5.66
5.32
4.59
3.23
1.77
0.28
0.05
0.00

2.38
1.86
1.38
667.79
400.80
383.63
304.51
254.31
192.34
180.85
156.26
109.87
60.16
9.37
1.70
0.10

88.92
69.61
51.57

371.16
224.43
211.32
168.70
140.73
105.75
100.00
84.98
61.52
33.26
5.16
0.89
0.03

82.66
62.67
45.99

Measures in the maximum drawdown risk framework

Jensens a
IR
MSR
FPI

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0.00
0.11
0.02
0.05
0.06
0.05
0.11
0.05
0.08
0.06
0.02
0.02
0.04

0.03
0.04
0.04

URP

1.88
1.37
1.57
1.44
1.23
1.09
0.90
1.09
0.38
0.30
0.05
0.02
0.01

0.93
1.14
0.93

Leverage factor

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Panels B and C of Table VI report details of rank for the out-sample and in-sample
period. The panels display the numerical values of these nine modified measures,
where five modified measures of Sortino, M2, IR, MSR, and FPI have same rank with
each other. Similar to the whole sample, the highest modified Sortino measure for the
out-sample and in-sample period belongs to Contrarian with the numerical value of
4.26 and 18.96, respectively. The evidence shows that the in-sample periods underperform the out-sample periods. In addition, the ranking of five measures of Treynor,
M2, IR, MSR, and FPI is also similar to the rank of Sortino measure in which Contrarian
dominates the other styles and also the in-sample period under-performs the outsample one. The highest numerical value of the modified Jensens a measure over the
out-sample period is associated with the value style with a numerical value of 0.01,
while this rank for the in-sample periods is related to the index fund style.
Among the management styles of mutual funds, the rank of S&P index over the
out-sample period of the modified measures is 12th for six measures of Sortino,
Treynor, M2, IR, MSR, and FPI, while the rank for the two measures of Jensens a and
URP is second and first, respectively. The rank of this index is different over the insample periods in which it is second for Sortino, Treynor, M2, Jensens a, IR, MSR, and
FPI. UPR is in first rank for this index. This is another reason which the in-sample
periods, due to the existence of financial crisis, under-perform the out-sample ones.
Among the management styles of mutual funds, the rank of MSCI index over the
out-sample period of the modified measures is 13th for six measures of Sortino,
Treynor, M2, IR, MSR, and FPI, while the rank for two measures of Jensens a and
URP is first. The rank of this index is different over the in-sample period in which it is
seventh, for five measures of Sortino, M2, IR, MSR, and FPI. This index for Treynor,
Jensens a, and UPR is 11th, 9th, and 1st, respectively. The better rank of the out-sample
funds than the benchmark indexes indicates the better performance of the funds rather
than the in-sample ones.
As reported in panel B of Table VI, four out-sample styles of contrarian, emerging
markets, equity income, and value have a modified leverage factor greater than one.
This implies that the M-DRM of the fund is less than the M-DRM of the market index.
Therefore, investors should consider levering the fund by borrowing money and
investing in the certain fund. This implication can also be followed by the six in-sample
styles of contrarian, emerging markets, geographically focussed, growth and income,
long-short, and index fund in panel C of the table. It means that we experience more
volatilities of the funds return below the market index over the crisis period (in-sample
period), thus it is natural which a more number of the sub-classes follow a levering
policy in the in-sample periods rather than the out-sample ones.
The majority of the styles in the in-sample period underperform the selected
benchmarks, as reported in panel C of table. In contrast, all of the styles in the outsample period over-perform the benchmarks. This again shows the inappropriate
effect of financial crisis in funds performance over the in-sample period.
In addition, seven out-sample styles index fund, growth, market neutral, blend,
growth and income, long-short, geographically focussed of the mutual funds have a
modified leverage factor lower than one. This means that the M-DRM of the fund is
greater than the M-DRM of the market index. Therefore, it implies that investors
should consider un-levering the fund by selling out part of holding in the fund and
investing the proceeds in a risk-free security such as a Treasury bill. This implication
can also be applied for the in-sample styles of blend, growth, equity income, market
neutral, and value in panel C of Table VI.

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3.6 A final digression: why do the M-DRM and its relevant b work?
The superiority of the M-DRM and MD-b upon conventional measures of SD, semi-SD,
b, and downside b in evaluating the performance of Malaysian mutual funds can be a
somewhat attractive result to some. In this section, we provide an attempt to
describe and justify empirically the plausibility of this finding. First, as described
above, a certain fund manager does not dislike volatility per se; rather he only dislikes
drawdown volatility. He does not shy away from funds that explain large and
considerable jumps greater than the mean; he shys away from funds that explain
frequent and large jumps less than the mean.
In fact, investors are not worried about getting greater than their minimum
acceptable return; rather they are worried about getting lower than their minimum
acceptable return. Moreover, aversion to the M-DRM is compatible to both the theory
and results in the literature of finance. Finally, the superiority of M-DRM and MD-b can
be associated with the contagion impacts in fund markets. Note that in the
conventional MV framework, the suitable measure of risk is the conventional b
when markets are integrated, and the conventional SD when markets are segmented.
The superiority of the MD-b can then be described by the fact that markets are more
integrated upon the M-DRM than upon the upside returns due to the contagion
impacts, something that data upon most markets seem to propose.
4. Conclusion
The conventional SD, b, semi-variance, downside b and their behavioral model
(MVB and MSB) have been extensively utilized but also extensively debated over the
past 40 years. Most of the debates against conventional risk measures have
concentrated on whether these measures evaluate more appropriately the performance
of mutual funds. This study reports and provides evidence that the data supports the
M-DRM and MD-b upon conventional risk measures. In this paper, we have generated
a parallel between the conventional framework in terms of MVB, MSB, b, downside b,
CAPM, and D-CAPM and a replacement framework in terms of the M-DRM; that is,
upon MDB, MD-b, and the alternative model based on it. Moreover, we have proposed
the appropriate method to estimate and test the MD-b and a, the measure of risk
suggested in this study, and how to extend it into the replacement pricing model
suggested in this paper to replace the CAPM.
The evidence described supports the M-DRM upon the conventional risk measures,
and, in particular, the MD-b. The empirical evidence also indicates that mean returns
are much more sensitive to differences in MD-b than to equal differences in the
conventional and downside b.
More specifically, this study improves and provides suggestions for the
risk-adjusted performance measures of the management styles of Malaysia mutual
funds. The appraisals are based on the modified performance measures grounded in
the modern portfolio theory. Using the MDB framework, this study modified nine
measures of Sortino, Treynor, M2, Jensens a, IR, MSR, UPR, FPI, and leverage factor
developed by Treynor (1965), Jensen (1968), Sortino and Price (1994), Modigliani and
Modigliani (1997), Sortino et al. (1999), Pedersen and Rudholm (2003), and Ferruz
and Sarto (2004). The evidence shows that the in-sample periods under-perform the
out-sample ones, because the in-sample funds (styles) performance were reported as
lower than the performance of the benchmark indexes which is due to inappropriate
effects of recent financial crisis. It also develops some implications based on the
modified leverage factor to invest in the funds.

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Finally, this paper questions the deficient frameworks in terms of MVB, MSB, b,
downside b, CAPM, and D-CAPM and suggests replacing them with a replacement
and more efficient framework in terms of MDB, the MD-b, and the maximum
drawdown CAPM.
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