Over the last decade behavioural finance has
gathered a lot of attention. Both the practitioners and academicians have started
accepting that investors usually do not make rational choice and their
investment pattern do not follow conventional finance theories. Conventional
theories state an assumption that investors are always rational, that is they
take into consideration all the available information and make an informed
choice. Behavioural finance is relatively a new field that combines
conventional finance and economics theories with behavioural and psychological
theories to give an explanation for irrational financial decisions. Several
psychological biasness effects the decision making of both individual and
In the present financial market, mutual funds have
taken an important role for saving and investment. It provides an alternative
avenue to invest in a professional and scientific manner. It plays a
significant role in development of capital market and the economy. Though it is
relatively new in India, it has seen a boost in growth in last few years.
Equity assets on mutual funds has increased from ? 2.2 lakh crores to ? 6.4
lakh crore in five years. It owns more than 10% of freely tradable shares by
value (Krishnan, 2017). This increase has been witnessed due to the active
participation of retail investors who now have reduced trading individually in
the market, and started investing in mutual funds.
Mutual funds are financial instruments which are
issued by Asset Management Companies. Mutual funds raise money from different
sources like retail investors, institutional investors etc. by issuing units.
They are managed by skilled professionals who identify the right instruments to
invest in and construct a portfolio that gives best possible return with
minimum cost. They invest the funds raised with a set investment objective and
manage it for a fee. They invest the funds mostly in equity or debt. It helps
to cover the problem of time and skills that individual investors face while
investing in the market. Since the investment is diversified among various
industry and sectors, it helps to reduce risk. Mutual funds issue
units to investors depending on the amount invested by them. Investors share
the profit and loss in proportion to their investment. Mutual funds with
various investment objectives are issued from time to time. It is required to
enrol a mutual fund with Securities Exchange Board of India (SEBI) before it
can gather cash from people in general.
There are some differences between stock investing
and mutual fund investing. When a person invests in a single stock he can face
a lot of volatility whereas one would face much less volatility in mutual funds
due to diversification. Investing directly in equities can make one super rich
very quickly, but the chances of this is very rare and the person will have to
undertake a lot of research and analysis to find such profitable stock. One
cannot expect unbelievable returns from mutual funds. One advantage that mutual
funds have is that he/she can invest in them through SIP (monthly investment).
SIPs are possible in stocks as well, but there is no diversification in them.
One can easily see that behavioural biasness can
affect the selection of mutual funds. For example, investors with “narrow
framing” bias (buying and selling individual assets without considering total
portfolio effects), “disposition effect” (selling winners too quickly and
holding losers too long), “overconfidence” (frequent trading plus poor
performance), or a preference for speculative stocks may select funds that
facilitate aggressive switching across asset classes without considering higher
fees. “Local bias” (preference for stocks of companies geographically close to
home) may induce the selection of locally-managed mutual funds without regard
to cost or expected performance (Bailey & et.al). This paper focuses on two
biasness namely loss aversion and dispersion effect.