Q. I am Aman Gupta. I want to diversify my investment portfolio. I am exploring mutual fund options that can provide long-term appreciation at minimum risk. How do I pick the right products?
Aman, assuming you are aware of the basic features of mutual funds, here are some parameters you must bear in mind to pick the right mutual funds.
Performance and consistency: Look for funds that have outperformed their benchmark index and peers over time. Analyse their historical performance across market cycles to gain a better understanding of their ability to generate returns in a variety of market conditions.
Stable management team: The fund manager's experience and track record have a significant impact on the fund’s performance. Frequent changes in the management team may lead to underperformance or changes in fund style.
Investment philosophy: Please study the positioning and strategy of the mutual fund before investing. Some funds invest solely in large-cap stocks and generate benchmark-aligned returns. Others may invest in small-caps, mid-caps or a combination for growth and alpha generation (better returns at no extra risk). Each fund or category of funds has a time horizon to maximise returns, which you must know.
Risk and volatility: Evaluate parameters like standard deviation, portfolio liquidity, risk-adjusted ratios, and drawdowns to understand the fund’s volatility in relation to the market. The risks associated with each category of funds are different, so the criteria related to the investment philosophy should be evaluated carefully. For instance, small cap funds are very volatile and demand evaluation of additional metrics like adjusted risk, liquidity, and alignment to the mandate.
AUM: The quantum of assets under management (AUM) can reveal how popular a fund is and how confident investors are about it. However, too large an AUM can make it difficult to effectively manage the fund's investment strategy.
Expense ratio: You get the expense ratio of a fund by dividing the total amount of fund fees (management fees plus operating expenses) by the total value of the fund. Compare expense ratios across funds. Over time, lower expense ratios will have a favourable effect on your returns.
Fund diversification: Consider the portfolio diversification of the fund across various market caps, sectors, and asset classes. A well-diversified fund that distributes its investments across different securities will pose a lesser risk.
Avoid duplication: Avoid duplicate mandated schemes or too many schemes in a portfolio. Duplication or overdiversification will reduce returns.