The UK equity unit trusts : time-varying market risk and idiosyncratic risk

Abstract

This thesis empirically investigates the risk of UK equity unit trusts by breaking down the total risk of trusts into market risk and idiosyncratic risk. This thesis constructs a research sample of 478 UK-authorized equity unit trusts from July 1990 to June 2015, exploring three research questions: the investment abilities of stock-picking and market return-timing; the investment ability of market volatility-timing and joint market timing; the idiosyncratic risk at the individual trust level. This thesis uses daily data to capture intermittent timing behavior and employs GARCH-type models to address the econometric problems of autocorrelation and heteroscedasticity owing to the employment of daily returns. This thesis documents how trust managers can time the market volatility successfully, whereas this is less the case with how they time the market returns. Moreover, data frequency cannot explain the empirical findings of reverse return-timing behavior. Volatility-timing evaluation is sensitive to data frequency, indicated by the opposite results obtained from daily and monthly data analysis. Trust managers select stocks to construct their portfolios. Stock’s idiosyncratic risk related to firm news and unpriced by market returns deserve as much attention as market risk. Our last study concentrates on the idiosyncratic risk of unit trusts’ portfolio that highly depends on trust managers stock-picking decisions. The study breaks down each trust’s total idiosyncratic risk into aggregate idiosyncratic risk capturing typical responses of trust managers to the public firm news and trust-specific unique risk assessing the risk-taking decision of each unit trust manager. We emphasise the relationship between realized returns of the unit trust and its unique risk exploring whether trust managers can produce high returns for trust investors when they take relatively high additional risk comparing to peers. The finding of significant positive relationship in the short-term across all trusts is favourable, supporting that managers are rewarded for their aggressive investment. Our finding can advise trust investors to invest in unit trusts with relatively high risk within their risk tolerance and capability. The positive relationship, nevertheless, is not consistent; thus, it is essential for investors to timely switch unit trusts timely.