BEHAVIORAL INVESTMENT TRAPS, FUND SIZE AND PORTFOLIO PERFORMANCE OF MUTUAL FUNDS IN KENYA.

Abstract

This study investigated the decline in financial performance observed among mutual funds in Kenya, focusing on the potential role of behavioral investment traps in influencing portfolio trends. The objectives were to evaluate the effects of herd behavior, loss aversion, overconfidence, and the disposition effect on mutual fund performance, and to examine how fund size moderates the relationship between these behavioral factors and portfolio outcomes. The results of this study will inform decision making by the policy makers. This will be done through provision of data and evidence to support policies and strategies that enhance financial performance. The results of this study will also guide on resource allocation as well as enhancing accountability by investors and it will also assist academicians to further their knowledge in the field of finance. Prominent theories include the Prospect Theory which is the main theory which explores how investors perceive gains and losses asymmetrically; Modern Portfolio Theory (MPT), which emphasizes diversification to optimize returns for a given level of risk; the Efficient Market Hypothesis (EMH), which postulates that market prices reflect all available information; and the Capital Asset Pricing Model (CAPM), which provides a framework for assessing risk and expected return in investment decisions. The population in this study comprised all 16 registered Kenya‘s mutual funds in the country. A causal research design was employed, utilizing secondary data from mutual funds’ financial statements spanning 2011 to 2021. Data analysis was conducted using multiple regression analysis model, employing panel regression methods with fixed and random effects models. Stationarity was tested using unit root tests, including the Levin-Lin-Chu, Augmented Dickey-Fuller, Im Pesaran and Shin, Philips-Perron, and Hadri 2000 tests. Normality was assessed using the Jarque-Bera test, and multicollinearity was evaluated through pairwise correlation analysis. The Hausman test was used to differentiate between fixed and random effects models, while skewness and kurtosis tests confirmed proper variable distribution. The findings revealed that herd behavior had a positive but insignificant impact on mutual funds’ financial performance (regression coefficient: 0.0004163). Loss aversion demonstrated a positive and significant effect (regression coefficient: 0.0627507), as did overconfidence, which had a strong positive influence (regression coefficient: 2.7295960). Conversely, the disposition effect negatively impacted financial performance significantly (regression coefficient: -0.5455628). The study concludes that overconfidence plays a critical role in shaping mutual fund performance and recommends emphasizing this factor in financial investment decision-making processes. Results indicate that fund size with a coefficient of +0.224458 has a positive moderating effect on the relationship between herd behavior and financial performance of mutual funds in Kenya. Fund size with a coefficient of -0.008639 has a negative moderating effect on the relationship between loss aversion and financial performance of mutual funds in Kenya. Fund size with a coefficient of -3.023683 has a negative moderating effect on the relationship between overconfidence and financial performance of mutual funds in Kenya and fund size with a coefficient of +1.056512 has a positive moderating effect on the relationship between disposition effect and financial performance of mutual funds in Kenya.