When you compare two funds with the same return over three years, prefer the fund with greater consistency
Selecting a mutual fund in the market place is not an easy task. There are over 50 Asset Management Companies with each AMC having an average of 30-40 funds. Then there are growth plans, dividend plans, reinvestment plans, direct schemes and broker schemes. Effectively, the total number of products is well above 4,000. Choosing the right fund within this range is quite a bit like looking for a needle in a haystack.
You can shortlist funds based on returns, risk, objective, tenure etc and allocate your money accordingly. Here is a five-point framework for you to identify the right funds to invest in.
Performance vis-à-vis benchmarks
The closest benchmark that one can get for fund evaluation is past performance. It is true that the past is not always a guide to the future. But if you were to consider the three-year rolling returns of a fund over a period of eight quarters, then you are likely to be able to shortlist performers. The whole idea is to beat the index fund and also be among the top performers in the peer group. One must also look at the consistency of returns. When you compare two funds with the same return over three years, prefer the fund with greater consistency.
Amount of risk taken
Apart from returns you also need to understand the risk that the fund manager has taken to generate the return. That is where risk-adjusted measures like the Sharpe Ratio and the Treynor ratio come in handy. These measures look at the return per unit of risk. That means your fund must either generate the best returns for the quantum of risk or take the minimum risk for the target returns.
We can look at this point more intuitively. For example, a 14% return on an equity fund with 10% volatility is quite impressive. However, 16% returns on a fund with 30% volatility is not too impressive. You need to put returns in the correct perspective.
Is the portfolio designed to optimise returns
Take an in-depth look at the portfolio mix before zeroing in on the fund. For example, in case of a diversified equity fund, ensure that it not overly exposed to specific sectors or specific themes. Also be wary if the portfolio is leaning more towards commodities or has an overdose of mid caps and small caps.
You need to adopt a different approach to a debt portfolio. For example, some exposure to ‘AA’ rated debt is understandable to enhance returns. But it must not make a chunk of your portfolio as it increases your credit risk. Similarly when rates are at a peak, avoid if the debt fund is too loaded on long-end of the yield curve. They are more vulnerable to price damage.
Stability of the management team
While investment in a mutual fund is supposed to be process-driven, ultimately it is the team that makes the strategy work. In a dynamic market, the fund management team has a lot of discretion. When the fund management team consisting of CEO, CIO, fund manager and dealer work together for a long time as a cohesive unit, then it shows in the performance of the fund. This applies to debt funds and to equity funds too.
Does this fund fit my long-term goals
This is the last but the most important question. The fund may be good on all the four parameters above. But if does not serve your specific needs, then it has no place in your portfolio. This logic applies to both equity and debt funds.
The writer is head of research and ARQ, Angel Broking
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