More people are now warming up to the idea of parking money in mutual funds. However, unlike fixed-income instruments that are simple and do not involve any business acumen, investing in mutual funds requires you to have sound financial knowledge and awareness of how the market is behaving. This is important as the fund’s performance depends a lot on the movement of its constituent stocks. Also, not mutual funds behave similarly, which means that you must select them depending on your financial goals.
Before choosing a mutual fund that you wish to invest in, you must know what to look at. A cursory look at the past three to five years’ returns may cause you to put your money in a fund that may not align with your financial goals in the long run. Assessing a mutual fund depends on a lot of factors like
Your investment goals
Why do you want to invest? What is the purpose of your allocating a part of your earnings to mutual funds? Do you understand the risks involved with market movements? How long do you wish to stay invested? Are you looking for regular income or dividends along with capital protection or intent on wealth creation? These are questions that you must answer yourself before stepping into the world of mutual funds that is varied and has a multitude of portfolios including equities, debt, government securities, gold, etc. It is important that you decide your financial goal first before moving on to select an appropriate investment vehicle.
Suresh Sadagopan, Founder, Ladder7 Financial Advisories, says, “We need to first know what we need to invest for and consequently the timeframe and the type of investment that could be suitable for the goal and mesh with the overall risk-reward suited to the client.”
Comparison is the key
Even the mutual funds in the same category perform differently. Not all give the same returns with some performing better than the other. Never look at a mutual fund in isolation. Compare its returns with its peer funds. You need not compare it with all the funds in the category. Just make a list of the funds performing consistently and then compare among themselves accordingly.
Deepali Sen, founder partner, Srujan Financial Services LLP (a Mutual Fund Distributor) says, “Comparison peer mutual funds in the same category allows to review their Volatility across market crests and troughs and across market cycles, how much of their performance is in sync with market movements. How much additional returns has one witnessed with the fund manager responsible for the respective funds, the expenses charged, the turnover ratio, consistency of fund manager, concentration vs diversification in the portfolio, etc.”
Check past performance
True that the historical performance of a mutual fund does not indicate its future performance. However, comparing the past five-year returns will give you a fair idea of how the market has performed during its various cycles. Apart, it will lend you a glimpse of the fund manager’s ability to manoeuvre through the continued ups and downs in the market to fetch you consistent returns in sync with your investment goals.
Prathiba Girish, Founder, Finwise Personal Finance Solutions says, “The fundamental purpose of investing is to generate returns most efficiently ie. Optimise returns while minimising risk. Hence, while we all know that past performance is no indicator of future returns, it remains amongst the most important metric that one needs to track. It’s important to track rolling returns, not absolute returns over various periods of time, especially during market downturns etc. The idea is to deliver superior returns consistently over various periods of time across cycles.”
The expense ratio of the fund
The fund manager would obviously charge you for his services, expertise and experience. The fee structure of the fund is in the form of an expense ratio which is deducted from the amount that you invest. Some mutual funds charge really high citing how their constant need to churn the portfolio underscores their agility and their ability to make quick decisions regarding buying, selling or holding of the assets. Though high performing funds charge high funds, it must not be construed that a high expense ratio is the hallmark of an extremely well-performing fund. There are other variants too that you must explore other than the fund’s fee structure.
Risk-adjusted returns
Some mutual fund houses post consistent returns over a period, thus, showing their ability to adjust their performance in the light of the risks related to the market and the industry. When fund houses deliver more returns as opposed to the highly anticipated risks, we refer to them as risk-adjusted returns.
Check the CRISIL rating of each fund to check its risk profile.
Performance against index
Every mutual fund is benchmarked against a particular index. This is done to evaluate the fund performances against that particular index. Comparing fund performances against the benchmark at different timelines can be helpful as it will help you understand if the fund delivers returns beyond index returns.
Consistency matters
A fund house must show persistence in its performance. This can be gauged from its returns over a period ranging between one and five years. A rocketing performance followed by very low performance underscores high volatility, and thereby, less stability. The more consistent the fund, the higher the likelihood to deliver consistently good returns over the investment period.
