The right equity mutual fund

The process of selecting mutual funds has been skewed towards evaluating the historical performance of the scheme, assuming that past performance will be replicated in future results. This is a common approach among investors when it comes to making investments.

This approach does not hold good in the current environment given the multitude of inter-linked global and domestic factors influencing stock performance. The first step for any investor is to decide on the objective of the investment in terms of returns expected and the time at hand. Once this is determined, one needs to gauge the risk taking appetite since investments in stock markets and therefore equity funds may go through ups and downs in the short term. Having worked out one’s own investment goals, choosing a scheme becomes a relatively easy task. Here are some parameters that can help you decide on your mutual fund investment in a more scientific manner:

Investment Objective

Like your own investment objective, every fund has an investment mandate or boundaries within which the fund manager can create his portfolio. One needs to ensure that the two objectives are aligned. Suppose one is not comfortable with having a volatile portfolio from the returns objective. It will then be prudent to avoid a small-cap fund that tends to be volatile in the short to medium term.

Portfolio composition

There is also a need to consider one's current portfolio to ensure that it is well-diversified to shield from any downfall if the underlying sector/ category (that the fund is invested in) were to undergo a correction suddenly. As such, if your portfolio is skewed towards thematic or sector funds such as IT, pharmaceuticals etc. one should consider adding diversified funds.

Risk-adjusted returns

Historical data gives an indication of the fund manager’s ability to deliver additional risk-adjusted returns compared to the benchmark. This indicates risk taken to generate extra return. When you align this parameter with your risk taking ability, it gives you a clear idea whether or not to pursue such investments.

Track record

When it comes to new funds on offer, one cannot analyse the past performance of the scheme. In such instances, you should look at the performance of other funds managed by the asset manager to get a sense of his/her credentials. Even in case of an existing fund, it pays to follow this approach to avoid performance aberrations wherein only a single scheme is doing well in the recent past, thereby reducing the probability of consistent performance.

Fund Corpus

Most investors focus on large corpus funds and think that the large size is an advantage. This is not always the case, and large funds may sometimes be a disadvantage. Consider this example: a large sized mid-cap fund would find it difficult to sell a stock of a small company since there may not be enough liquidity in the market. Similarly, such a fund placing an order for a mid-size stock with limited liquidity will find it difficult as compared to a relatively smaller size fund.

Fund Ratings

Among the recent developments in mutual fund evaluation is the availability of comprehensive fund performance ratings wherein reputed agencies (domestic and international) conduct a comprehensive performance analysis of funds on critical parameters like risk adjusted returns, portfolio composition, asset concentration, liquidity etc. The agency then assigns a specific rating (e.g. 5 star for high performing funds to 1 for poor performing funds). One can look at ratings conducted by agencies like CRISIL, Value Research, Morningstar, Lipper, ICRA.

Source: http://www.indianexpress.com/news/the-right-equity-mutual-fund/815593/0