Effect of Financial Risks on Financial Performance of Mutual Funds in Kenya

Abstract

The purpose of the research was to discover whether or not financial risk affect how mutual funds in Kenya perform financially. The research employed longitudinal survey study approach. The research targeted all mutual funds in Kenya. There were twentyfour (24) approved fund managers by Capital Markets Authority (CMA) as of December 2022. Data was collected from all of them for 2017-2021 period. Data of secondary nature was gathered regarding financial risks and financial performance from annual published reports. A multiple regression analysis was also performed. The study's findings indicate a significant and positive correlation between Return on Assets (ROA) and total assets. ROA and expense was discovered to have a strong positive and significant correlation. Credit, interest rate and liquidity risk however did not have a significant correlation with ROA. Their correlation with ROA is positively low. The adjusted R2 of .643 indicated that approximately 64.3% of the fluctuations in the financial performance of mutual funds in Kenya was accounted for by the extent of financial risk exposure. Total assets and expense ratio influenced this relationship. Additionally, the study's results indicated that financial risks, which are comprised of interest rate, liquidity and credit risks reliably predicted financial performance (ROA) of mutual funds in Kenya. Finally, regression coefficients established that 47.3% variation in Kenyan mutual fund performance financially is due to changes in any of the determinants included in the regression model, with all of the other variables in the model's independent set remained constant. A stronger positive and statistically significant effect on ROA was also found to be associated with total assets and the expense ratio as given by β=.803, p<0.05. ROA was also positively impacted, if little, by the risks associated with credit and interest rate fluctuations. However, the detrimental impact of liquidity risk was statistically insignificant on ROA. The study concluded that financial risks, made up of interest rate, liquidity and credit risks reliably predict how mutual funds in Kenya perform financially. Based on correlation coefficient, ROA correlates positively and significantly with overall assets as well as expense ratio. Credit, interest rate and liquidity risk however did not have a significant correlation with ROA. Their correlation with ROA is positively low. The conclusion from the regression coefficient was that total assets and expense ratio have higher positive and statistically significant effect on ROA. Credit and interest rate risk had a low positive effect that was statistically insignificant on ROA, and liquidity risk had a lower negative effect that was statistically insignificant on ROA. Based on the conclusion, management of mutual funds should put in place a robust financial risk management system that would ensure optimal ROA, based on the various risk exposures. The management would also adopt the use of hedging, diversification, insurance, risk transfer, scenario analysis and stress testing, tailored to deal with specific risks.