Do Stock Market Risk Factors Explain Mutual Fund Returns? Evidence from Saudi Arabia

Abstract

This paper examines the risk factors of the Saudi Arabian equity market using an extensive data set. The study demonstrates which risk factors explain mutual fund returns in the largest mutual fund market in the Middle East, a fast-growing economy and a major player in the oil market. This paper also assesses the global and emerging market risk factors. This study analyzes 256 equity funds that operated in Saudi Arabia from January 2006 to July 2017. Time series regression models (e.g., the CAPM, the Fama and French three-factor model and the Carhart four-factor model) are used. In addition, modified versions of the asset pricing models were applied by adding stock market volatility and oil market volatility. The results indicate that the single-factor model, representing the market portfolio, captures most of the mutual funds’ excess returns. Size, value and momentum factors do not enhance the explanatory power of mutual fund returns significantly. The emerging market risk factors capture a small portion of the return variations where most effects were explained by the market risk factor. In explaining these results, we emphasize the important implications for investors, academics and regulators to better understand the risk factors that drive fund returns in a fast-growing emerging market.