Mutual funds sahi hai!

And if you are a seasoned investor, you will know that mutual funds gained a lot of traction over the past few years.

The Assets under Management of the Indian mutual fund Industry has grown from ₹ 4.13 trillion in 2008 to ₹22.86 trillion in 2018. This marks for about 5 ½ fold increase in a span of 10 years.

A lot of common investors have now begun investing in mutual funds via the Systematic Investment Plans (SIPs). This number is only set to increase.

Assuming you invested in mutual, there could be 2 ways to go about this.

Either you invest in mutual funds yourself, or you consult a financial adviser or expert. Ideally, you would want to opt for the first option as it saves paying consultancy and / or commission charges on your investments.

But do you have the requisite know-how to invest in mutual funds yourself?

Don’t worry, this article seeks to address this gap.

Let’s see how you can analyze a mutual fund!

To learn the basics about mutual funds, read further.

6 Parameters to Analyze Whether a Mutual Fund Is Right for You

1.Expense Ratio

Expense ratio is the percentage of total assets that a mutual fund charges an investor annually for managing their money.

The expenses related to Mutual Funds fall into 5 categories-

  • Distribution charges;
  • Security transaction fees;
  • Management fee;
  • Investors transaction fee;
  • Fund service charges.

Basically, the expense ratio reduces the returns available to the investor. Therefore, an investor should look for funds with lower expense ratio.

You must be thinking – how does the expense ratio of a scheme affect the returns?

Mutual fund schemes are usually categorized into – Direct and Regular Plans.

Both these plans are exactly the same, as they are run by the same fund managers. The funds in both the plans are invested in the same stocks and bonds, making the portfolio essentially the same.

The difference lies in the fact that direct mutual funds charge no broker/distributor commission and other charges.

On the other hand, regular mutual fund schemes charge broker or intermediary fees or commission. This is because usually mutual funds are sold through brokers and intermediaries.

This commission is added to the expense ratio of the fund making it more expensive than the direct plan. The commission usually amounts to 1% – 1.25% per year. The difference can be observed in the NAV and returns of the 2 plans.

Therefore, investors must compare the expense ratios of the various funds before investing in one. Obviously, the fund with the lower expense ratio is preferred

2.Fund Performance vs Benchmark Performance

Best multicap funds of 2019

So this is one of the first things most investors check for in a scheme.

However, what percentage return indicates a good performance? How do you know whether your selected fund has performed well or not?

The performance of a particular fund must always be compared with the performance of the respective benchmark for the fund. Each and every scheme necessarily has a benchmark, which it aims to outperform.

To understand this point, let us take the help of an example.

Let us assume that you invested in a particular mutual fund scheme. After a year, the total returns provided by the scheme is 20%.

You must be thinking that the return looks pretty decent, right?

Not necessarily.

As you might have heard, a popular saying goes- ‘The devil is in the details.’

Now, what if I tell you that during the one-year in concern, the benchmark for the particular fund generated a return of 25%.

Now, did your fund perform better or worse as compared to the benchmark?

Yes, you got it right. If you would have simply invested in the benchmark index, you would have made 25%. Whereas, upon investing in the concerned fund, you made 5% less.

If a fund generates excess returns over the returns of the benchmark, then the quantum of excess returns is referred to as the fund’s alpha.

Therefore, the moral of the story is, it is always advisable to compare the returns of a particular fund against its benchmark index. Investors must always look for positive alpha in a fund.

If the concerned fund has consistently outperformed the benchmark index, then you tick this particular checkbox.

3.Risk Level

Checking for the risk level of a scheme is as important, if not more, as checking for returns.

In the world of mutual funds, risk and returns are 2 sides of the same coin.

There is a very important reason, why each scheme discloses its risk level. The risk is defined so that the investor is aware as to how much risk does the particular investment entail.

Usually, the risk is defined with the help of the following 5 categories- low, moderately low, moderate, moderately high and high.

Are you thinking, what do we do with the given risk level of a particular scheme?

The simple answer is, the risk should fall within your risk appetite. If you are an investor with a low or moderately low-risk appetite, then you should avoid high-risk funds

Moreover, you must also check for risk-adjusted returns. If the fund has a higher risk level, then it only makes sense to invest in that fund if it gives higher returns sufficient to commensurate the risk.

4.Fund’s History

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The real test for a mutual fund is its long term performance.

A good fund is one which has generated consistent and stable returns over a period of 5-10 years.

The fund will usually see at least one down business cycle. This gives the investors confidence that the fund can deliver returns, not only in the bull cycle but the bear cycle as well.

To understand this, let us take the help of an example.

Example 1:

Suppose a fund generates a return of 12% in the previous year but did not do too well in the preceding previous years.

But looking at the good performance of last year, you decided to invest in the scheme.

However, going forward, in the next year, the markets performed poorly. Markets registered a loss of 5%. However, the fund registered a loss of 9%.

Now, the investor would find himself/herself in a fix.

The moral of the story is that an investor should look at the history of the fund. Specifically, the performance of a fund over a period of at least 5 years.

5.Portfolio Turnover Ratio

Portfolio Turnover Ratio tells you how frequently the fund manager buys/sells securities from the fund.

You may wonder, why is that relevant to you?

It is important to you because the higher the portfolio turnover ratio, the higher the buying/selling of security. This, in turn, would attract higher transaction charges in the form of brokerages and other fees.

A portfolio turnover ratio, thus, reduces your net returns from the investments.

Investors can use these two to calculate the net take-home return and compare funds.

Example 1:

There are 2 funds in consideration. Let’s call them to fund A and fund B respectively.

The returns for them are 10% and 9% respectively. Given this limited information, it seems like fund A is a better choice.

Now, the expense ratio for the 2 funds is 3% and 1% respectively. This changes the equation, a little bit.

The net returns from fund A and fund B are 7% and 8% respectively. Given this information, fund B becomes more preferable.

All in all, while analyzing a mutual fund scheme, it is a good idea to have a look at the portfolio turnover ratio, along with the expense ratio.

6. Fund Manager

Apart from the above-mentioned points, there are some other aspects which can also be looked upon.

The performance and history of the fund manager are crucial.

An investor can look at the experience which the fund manager has, other schemes that the fund manager is managing and so on.

This increases the reliability and confidence that your hard earned money is in safe hands.

Moreover, the reputation and history of the fund house, under which the scheme belongs can also be looked upon.

Conclusion

Knowing what to look at while evaluating a mutual fund, leads to the selection of a good mutual fund. This knowledge can go a long way in helping you make the correct investment.

It must always be kept in mind that investment in mutual funds is subject to market risks. Therefore, proper due diligence is beneficial.

To look at some of the best performing funds from every category of mutual funds, check out Groww 30: Top funds in every mutual fund category.

Happy Investing!

Disclaimer: The views expressed in this post are that of the author and not those of Groww