The effects of regulations in the retail fund industry on retail investors

Abstract

The thesis uniquely describes the effect of retail mutual fund regulation on investors. Focusing on the UCITS and US mutual fund regulations, the study tests the effectiveness of these regulations in context of the financial crisis along with the effects of the recent regulatory initiatives on the investors. The study uses the Fama-MacBeth regression method to find the risk premium of various risks, including the following: liquidity risk, default risk, emerging market risk, inflation risk, market risk, interest rate risk, and borrowing risk, which are transposed to the investor before, during, and after the crisis. The study concludes that the regulation undertaken after the financial crisis made the managers of both UCITS funds and US mutual funds reduce their risk exposures. The analysis proposes a case for deregulation, as it highlights that the Dodd-Frank Wall Street Reform and Consumer Protection Act made fund managers more exposed to tail risk. Similarly, the study tests the effects of UCITS V and discovers that retail funds reduced their tail risk after UCITS V was set in place. The thesis makes use of the value at risk, “VaR”, expected shortfall, “ES”, and standard deviation of residuals to define how the financial crisis affected the total, tail, and idiosyncratic risk, “IR” of retail global equity funds. The study discovers that before the financial crisis, retail mutual funds entailed more tail, total, and idiosyncratic risks. However, overall it can be gleaned that US mutual fund regulation provided a more effective response to new regulations, guidelines, and bailout programmes that aimed at reducing the risk levels. The study also tested whether the means return between the samples is identical. This section implied that different levels of risks do not necessarily imply different returns. This stems from the idea that while the risk levels between the pre-crisis period and at-crisis samples are identical to each other; however, the return of the UCITS funds in the pre-crisis sample is different from that in the at-crisis sample. The study compared the returns and alphas of the US and UCITS funds. The results indicate that in the pre-crisis period, the UCITS and US funds had divergent return levels, while the risk levels of the funds were identical. Namely, UCITS funds offered more return for the same mean risk as that offered by the US funds. This implies that the divergence of UCITS fund regulation was helping investors achieve better return for the same risk level in the pre-crisis period. After the financial crisis, these two separate funds experienced very similar risk and returns profiles. The paper thereby concludes that the regulations that were made after the crisis made this alignment possible. Finally, the analysis also raises concerns about the effectiveness of the restrictions, as the study finds that global equity funds were following the markets of ineligible assets.