Often investors like showered with a lot of information on
how to assess a mutual fund scheme but never are they guided on how not to
evaluate a mutual fund scheme. PersonalFN highlights few points which many a
times investors fail to consider while investing in a mutual fund scheme.
A lot of mutual fund advice/research now-a-days is focused
on how investors must evaluate mutual funds. You must have come across a lot of
literature on this in a newspaper or on websites of mutual fund houses. Even
your distributor / relationship manager / agent must have showered you with a
lot of information on how to assess a mutual fund scheme before investing in
the same. Unfortunately, in our view that is often not enough. It is like knowing
only half of the story, which then leads to mis-selling by self-centred
distributor or advisors. As a result, a lot of investors who end up investing
in mutual fund schemes which lacks consistency in performance are left very
disillusioned with how their investments have performed. All this can be
prevented if investors are armed with two golden rules to invest in mutual
funds "guidelines on how to evaluate a mutual fund" and just as
importantly "guidelines on how not to evaluate a mutual fund". Over here
let us discuss the other half of the story i.e., guidelines on how not to
evaluate a mutual fund which is generally very less discussed about.
1. Don't read too much into past performance
Read any mutual fund advertisement and there is likely to be
a mention of the funds incredible performance over the years. At times the
focus on past performance is so overwhelming that it leaves you with the
impression that, past performance is all that matters while investing in a
mutual fund. However, in our view, past performance is important, but it is
just one of the factors that must be considered while investing in a mutual
fund scheme. Among other factors that rarely find a mention in advertisements
are the fund houses investment philosophy and processes, level of ethics,
performance across market phases especially during the downturns of the stock markets.
2. Don't read too much into mutual fund ratings
In our view, mutual fund ratings get more than their share
of attention from investors, which is unfortunate. This is especially true
since in the Indian context mutual fund ratings are often biased towards
returns with little or no room for evaluating among other factors, the fund
house's investment philosophy, processes, track record on transparency,
consistency, compliance and ethics. Such lopsided ratings cannot be the base
for investors to take a decision whether to buy or sell or hold a particular
mutual fund scheme. However, ratings can be considered as a reference point
while evaluating different types of mutual fund schemes.
3. Don't read too much into CAGR performance
One of the many selling points for mutual funds is their
performance in terms of compounded annualised growth rate (CAGR). Any student
of mathematics can confirm this "CAGR is just an indicator of growth
between two points" (or between two dates as in the case of a mutual fund
investment). It tells you nothing about what transpired in the interval and
more importantly it tells you nothing about the risk the mutual fund has
exposed investors to and the investment process that generated that CAGR. At
the end, the CAGR hides more than it reveals which is why investors should not
read more in it than necessary.
4. Don't invest in a mutual fund just because its NAV
is low
Many a times you perceive investment in a New Fund Offer
(NFO) as a good investment just because the NFO is priced at Rs 10. On a
similar footing, even existing mutual funds with lower Net Asset Value (NAV)
appeal you more as compared to a mutual fund with a higher NAV. In our view,
this approach to selecting a mutual fund is absolutely incorrect. Let us
understand what constitutes or how NAV of a mutual fund is arrived at. The NAV
of a mutual fund is expressed as total of all assets of the particular scheme
less the liabilities of that scheme (excluding liability towards unit holders),
divided by the total number of outstanding units.
Thus, when you invest in a mutual fund you invest at its
existing NAV wherein you buy units at a price (i.e. the NAV). The calculation
of the NAV is based on the current market price of all the assets that the
mutual fund scheme owns less the liabilities. In other words, the NAV
represents the mutual fund scheme's intrinsic value.
Unlike in stocks, wherein the stock price of a company is
different from its intrinsic value due to fact that the investors evaluate the
company's future profitability and accordingly pay a higher price or lower
price as compared to its book value. This does not hold true for open-ended
mutual funds - they always trade at their book value; so investors never
buy them cheap or expensive in that sense.
5. Don't count on the star fund manager
Unlike other factors like past performance that merit some
(positive) consideration, the presence of a star fund manager merits no such
consideration. On the contrary a fund house must be given negative marks for
attributing its success to a star fund manager. While over the short-term a
star fund manager may bring about a dramatic change in the mutual fund's
performance, over the long-term he can do more harm than good.
As a mutual fund's performance gets inseparably linked with
the presence of the star fund manager, his existence in the fund house becomes
a prerequisite for the fund's success. If the star fund manager quits the fund
house, it could leave the fund and its investors in the lurch because the
existing team is unlikely to be capacitated to deliver on the same lines as the
star fund manager.
So what must investors do? Go for fund houses that institutionalize the fund management process by building teams that are guided
by well-defined processes where individuals have a limited role to play.
6. Don't question every investment decision made by
your fund manager
While it's good to be aware of what your fund manager is up
to, it is only in the fitness of things that you let him do what he is good at
doing, which is identifying the best investment opportunities ahead of the
competition. As an investor you must do what you are supposed to do which is
getting your financial planner involved in the process of keeping a tab on your
investments. The financial planner (provided he is honest and competent) should
be the one to tell you whether the fund manager is investing in line with his
pre-determined investment mandate and philosophy. Once you understand the roles
defined for all three parties over here "fund manager, financial planner
and you", (i.e. the investor) you will not waste your time organizing over
views like whether your fund manager is doing the right thing by investing in
software stocks in the backdrop of a rising rupee and so on.
Thus, the next time you plan to invest in a mutual fund
please take a note of the above 'must avoids' along with the guidelines on how
to select a winning mutual fund for your portfolio.
Source: http://www.moneycontrol.com/news/mf-experts/how-not-to-evaluatemutual-fund-scheme_751874.html
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