Selecting a Winning Mutual Fund

Where should you invest money is one of the most crucial financial decisions to be made. There are different investment options available in the market which makes it difficult to choose which one is suitable for your financial requirements. Some of the investment options include stocks, bonds, shares, and other money market instruments. In such situations, investing in mutual funds is the best option for your investment requirements. This is because of below mentioned two primary reasons,

1.    Mutual funds keep you stay well invested in markets.

2.    You don't have to worry about the tracking of the investment portfolio on a regular basis.

If chosen carefully, some of the mutual funds (MFs) also have the capability to double one’s wealth over the long term. However, selecting the best mutual fund to suit one’s requirement becomes difficult because of the availability of a large number of schemes in the market. Therefore, instead of just following mutual fund investment tips given by your friends and relatives, you need to check many things before investing in a mutual fund.

Investment Objective and Risk appetite: As MF documents come with a statutory warning that - Mutual fund investments are subject to market risks, you should first read the offer documents carefully to determine that the particular fund meets your investment goals or not. Investment objective and Risk appetite is of epitome importance before we indulge ourselves in Mutual Fund. Why we are investing? Investment objective might be long term, short term or linked to any event like kid's marriage, education, retirement...Etc. Secondly, depending on investment objective the risk factor can be decided. In short, as an investor how much risk you can take with your investments. Attach a goal to your investment in mutual funds. If you are investing in equity funds, invest for the long term. Every investment needs time to grow. Patience is the key to success.

Performance: As Mutual Fund documents come with a statutory warning that – Past Performance is Not Indicative of Future Results. So, what to do?

If you are entering out of greed in an overheated market, choosing the top-performing fund will be nothing but picking the most risky one. You may soon find the fund at bottom of the performance table when the overdue correction eventually takes place.

However, if you are entering the market in a down cycle with proper financial planning, you may rely on the performance table as the fund with risks well managed would be up on the table in a down market.  

Watching at past performance of the fund is important in analyzing a mutual fund. But Note that, past performance is not everything, as it may or may not be sustained in the future and, therefore, it should not be used as the only parameter to select a mutual fund. What you should be looking for is the fund’s performance in different cycles. Look for consistency rather than ranking.

For example, in the case of debt funds, where returns of various funds are almost identical, managing risk is most crucial than focusing on generating returns. So, check the experience and track record of fund managers in managing debt funds.

In case of equity funds, instead of going by recent performance, check consistency in performance of the fund in long-run – say in 05-10-15 years, along with experience of fund managers and for how long they are managing the fund.

Fund House: A fund house or an asset management company is the company that manages Mutual Funds. The job of a fund house is to invest pooled funds of retail and institutional investors in equity, fixed income or other such securities in line with the stated investment objective of the fund. Hence, it is very important to do a check on the fund house with respect to its history of existence, reputation of management, track record across the schemes before selecting a Mutual Fund.

Fund Manager: Checking the experience and track record of fund managers may ensure that you have given your hard-earned money in competent and deserving hands. A fund manager with expertise in finance and ethical history will be an ideal candidate. We can have an idea of performing fund managers from checking with any leading Business Daily through online mode. If you find yourself holding a mutual fund with a manager that has little or no track record or, even worse, a history of massive losses when the stock market as a whole has performed well, consider running as fast as you can in the other direction.

The ideal situation is a firm that is founded on one or more strong Fund Managers that have built a team of talented and disciplined individuals around them that are slowly moving into the day-to-day responsibilities, ensuring a smooth transition. It is in this way that firms such as HDFC, ICICI Prudential, Franklins Templeton...etc have managed the market-crushing returns while having virtually no internal upheaval.

Finally, check to see if the managers have a substantial portion of their net worth invested alongside the fund holders. It’s easy to pay lip service to investors but it’s a different thing entirely to have your own capital at risk alongside theirs. 

Review the MF scheme & investment style: After having done with the evaluation of the fund manager, the broader investment style of the scheme should be well recognized. A scheme which is aligned with your objective and is in line with your risk profile is the scheme which you must opt for.

Assets Under Management (AUM): The fund with a large asset size generally gives the investor confidence that a large number of people have shown confidence in the fund and have subscribed to it. This confidence is built over a period of time. Secondly, fund houses deploy their best fund managers for flagship mutual fund schemes with high AUM. Therefore on this parameter, you may drop mutual fund schemes with below-average AUM in particular mutual fund sub-class.  

Underlying Asset: One should check about where is the money actually being invested in? Is only debt or debt + equity or only equity? What is the percentage of allocation? The choice of asset class is very important and it should have features aligned with the investment objectives.

Funds that have a high concentration in particular stocks or sectors tend to be very risky and volatile.

The portfolio turnover rate refers to the frequency with which stocks are bought and sold in a fund’s portfolio. High the turnover rate, the higher the churning and volatility. This leads to higher transaction costs and in turn translates into funds higher expense ratio.

   

Entry & Exit load: An entry load is the charge put on you at the time of joining the fund and exit load is the charge levied when you sell your units of a mutual fund within a particular tenure. As entry & exit load is a fraction of the NAV, it eats into your investment value. Thus, it is imperative that you invest in a fund with a low entry & exit load, and more importantly stay invested for the long term. Entry loads as a concept has been abolished in India since 2009. An exit load is charged when you sell units of a mutual fund within a particular tenure. Most funds charge exit load if the units are sold within a year from the date of purchase.

Expense Ratio: While calculating returns from the scheme, it is advisable to check the expense ratio as the expense ratio eats into returns from the scheme. Normally schemes with expense ratio of up to 1.5% are considered OK as per industry experts. Higher expense ratios may not impact good performing mutual fund schemes too much but will hit hard when funds start performing badly.

Compare Funds: Check fund performance, expanse ratio, AUM and compare it with its peers from the same category. One should check returns given by a fund during different time periods and compare them with a benchmark, usually an index and other funds in the same category. “This will help you to know how volatile the fund as compared to other funds is and if it is a correct fund for you, considering your investment attributes.

Taxation effect: It is important that you inquire of the tax liability arising from a particular scheme, before you plan to invest your money in it.

Common Mistakes while Choosing Mutual Funds

Selecting the Right Mutual Fund is like selecting Right Life Partner. Any wrong decision can wipe out your personal wealth. What makes it more difficult is volatility in the performance of mutual funds.

MF Ranking: Some people select Mutual Fund only on the basis of their rankings. They often misunderstood the volatility of the underlying assets. A star performer fund this year might be the worst-performing fund next year. It is advisable to review the investment portfolio every 6 months. In short, undertake the exercise of selecting the right mutual fund every 6 months.

Star Fund Manager: You should avoid funds that owe their performance only to a “Star” fund manager. Simply, because, if the fund manager is present today he might quit tomorrow and hence the fund will be unable to deliver its star performance without its star fund manager. Therefore, the focus should be on the fund houses that are strong in their systems and processes.   

MF diversification: A lot of investors harbor this misconception. They think holding a large number of funds diversifies their portfolio. That’s a fallacy, because all it does is make the portfolio difficult to monitor. The portfolios of the various funds are not very different. The percentage allocation may differ slightly but the funds will essentially be investing in the same basket of stocks. If you invest in three large-cap funds, your portfolio will not be very different than if you had invested in just one of those funds. If you really want to diversify, spread your money across 4-5 funds from different categories of equity funds. For instance, if you are an aggressive investor, you can allocate 60% of your portfolio to mid-cap funds, 20% to multi-cap funds and 20% to large-cap funds. In such a scenario, two mid-cap funds, one large-cap fund, and one multi-cap fund would suffice.

Do not go blindly with suggestions: Ask questions to understand why your advisor or distributor suggesting specific funds. A good advisor wouldn’t mind it to explain.

SIP is not a solution for every goal: SIP is a route of investment and not compulsorily suitable for every goal, duration or type of scheme. In addition, SIP is a mode of investing in mutual funds and not any mutual fund scheme.

ELSS is not an investment only for 3 years: ELSS funds are multi-cap funds and carry risk. Therefore, it is always recommended to stay invested for the long term after lock-in is over. Also, avoid investing in too many ELSS funds.

SIP and ELSS: When one invests in ELSS through SIP mode, each installment gets locked for 3 years. Keep this in mind.

Growth or Dividend option: Choose option wisely. Growth is always recommended. Avoid dividend option if you do not need any regular cash flow or additional income source.

Mutual funds are always not about equity: Mutual fund investments are not always about equity schemes. There are many options like debt schemes, liquid funds, gold, etc.

Mutual funds are not for trading: Avoid switching or redeeming mutual funds to book profit and reinvest some in other funds for the short term. Mutual funds are not stocks to trade.

Low NAV does not mean more profit: If you are investing in a scheme just because its value is low, does not mean you are buying it cheap or going to earn more profit as compared to a high NAV scheme.

 

 

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