1. Why should you compare mutual funds?
You might have come across a plethora of mutual funds offering various benefits at nominal investment. However, at the first instance, all the funds in a particular category look similar making it a challenge to take a wise decision. After all, investing is indeed a long-term venture and you need to be aware of what you are getting into. Most of the investors utilise fund returns as the only criteria to measure and compare performance across funds.
Basically, fund returns is the difference between the Net Asset Value at the beginning and Net Asset Value at the end for a given period of time. Annualised returns just tell you about the value addition/reduction during a given period. But what about consistency of returns, quality of fund house and risk-adjusted returns. For choosing the right fund, you need to compare mutual funds on these grounds as well. By using some of the financial ratios you will be able to make the right decision.
2. How to compare mutual funds?
Selecting the appropriate mutual funds is the first step towards earning returns on the expected lines. In order to arrive at the best mutual funds, you need to possess the art of comparing the funds. All you need is to start with your investment objective. When you know your goals, you can easily decide what to look for in a fund. You may use the following parameters to compare a set of mutual funds:
It provides a yardstick against which you can measure fund performance. It indicates how much returns the fund has generated as against how much it should have delivered. As per SEBI ‘s mandate, each fund declares its benchmark and considers it as a target to analyse performance. If index rises by 12% but NAV of the fund rises by 14%, then the fund is said to have outperformed the index. Conversely, if the index falls by 10% but the fund loses by 12%, then the fund is said to have under-performed the index. Basically, comparison should be made to look for a fund which gains more in a market rally and loses less in a slump.
Your investment horizon becomes a driving factor for fund selection and comparison. Investment horizon relates to the time period for which you stay invested in the given fund. The type of fund chosen for comparison should be according to the investment horizon. Equity funds are suitable for a long term horizon of at least 7 years or more. The fund objective in this time period is wealth accumulation at a relatively high risk. Similarly, for investing surplus funds for short term, liquid funds give better returns than savings bank account. Here, the fund objective is safety of capital along with moderate returns.
From this context, the fund returns selected for comparison should match the investment horizon. It means that while comparing two equity funds, you may consider fund returns of past 5 to 10 years. In the same way, for comparing two liquid funds, consider fund returns of past 6 months to 1 year. Select the fund which has given superior performance across different time intervals.
Whenever you invest in any mutual fund, you undertake some kind of risk. This risk relates to variability of fund NAV as per the overall market movements. According to investment thumb rule, higher risk needs to be rewarded with higher returns. But plain vanilla returns do not reflect this aspect of a mutual fund. Thus, you need to use a better measure for comparing two funds on the grounds of risk-adjusted returns.
You may use alpha and beta for this. These are financial ratios which tell you about rewarding potential of a mutual fund. Beta tells you how much risk is involved in investing in a fund. Alpha tells you how much extra return will the fund generate over and above the underlying benchmark. See, your target is to beat the benchmark and not to imitate it. Supposes two funds are at the same level of beta i.e. 1.5. Fund A and Fund B has alpha of 2 and 2.5 respectively. Fund B is better because it gives higher risk-adjusted returns.
Your investment in mutual funds comes at a cost called the expense ratio. It is an annual fee which the fund house charges to the unitholders to manage portfolio on their behalf. The level of expense ratio has a direct impact on the level of fund returns earned by the investors. It is because expense ratio is charged as a percentage of fund’s asset under management. A higher expense ratio ultimately dents the profits earned by the investors. Look for a fund which has the lowest expense ratio in the given category.
While using the expense ratio, you need to keep a few things in mind. The expense ratio of direct plans is lower than that of regular plans due to absence of distributor commission. Compare one regular fund with other and one direct plan with other. Do not compare index fund with an actively managed fund. The expense ratio of index fund is lower due to low fund management fee. Compare active funds with active funds. Do not compare equity fund with debt fund. Owing to higher transaction cost and brokerage, equity funds have higher expense ratio than debt funds.
A mutual fund scheme allocates your invested capital according to its investment objective. As regards asset allocation, SEBI has given a mandate which every fund in a particular category follows. If you consider a multicap equity fund, it will have at least 65% of capital allocated to equity shares of different companies. Such an allocation impacts the risk profile of the fund. But two funds of the same category need not have identical sector allocation.
Fund A might have invested more in financial services whereas Fund B might have invested more in FMCG companies, while staying within SEBI mandate. So, this makes Fund A less risky than Fund B. Similarly, some fund might be taking concentrated bets to earn higher returns. While comparing two funds, you should compare the sector allocations also. Match the fund risk profile with your risk appetite and choose accordingly.
3. What are the quick pointers for Fund comparison?
- Compare 3 year returns of one fund with 3 year returns of other fund. Don’t compare 3 year return of one fund with 5 year return of another.
- Compare fund returns of large-cap funds with the given broad-based index like BSE Large-cap and not with BSE Mid-cap index.
- Compare growth plan of one fund with growth plan of another. Don’t compare growth plan with a dividend plan.
- While comparing funds, choose funds which have a considerable fund history of say at least 5 years. This ensures that the fund remained resilient in the domain from quite some time.
4. How to invest in Equity Funds?
Many a time investing in equity becomes complex. In case you don’t possess enough financial knowledge and are finding difficult it too difficult to understand, then just go for ClearTax Invest. Here, instead of directly investing in equities, you can try investing in Equity Funds. You can choose hand-picked equity funds in a hassle free and paperless manner.
Using the following steps, you can start your investment journey:
Step 1: Sign in at cleartax.in
Step 2: Enter your personal details regarding the amount of investment and period of investment
Step 3: Get your e-KYC done in less than 5 minutes
Step 4: Invest in your favourite debt fund from amongst the hand-picked mutual funds.