How to Check Mutual Fund Performance? – Mutual Fund Historical Performance, Analysis & Expense Ratio Check

When it comes to investing in mutual funds, you need to know how to analyze and pick funds that are best suited for you. Most beginners look at returns, riskiness or ratings of a fund before investing. Here are a few more performance indicators that will help you make the right decisions in mutual fund analysis. We have covered the following in this article:

Compare Mutual Fund Performance against a Benchmark

You may start by comparing the performance of a fund against the benchmark. When you compare, use a fair and appropriate benchmark. It should always be an apple-to-apple comparison. Using the wrong yardstick will only give misleading data.

Let’s take the case of a Large-Cap Equity Fund. Compare its performance with a broad-based index like Nifty 50.

Compare Fund history

A mutual fund’s real worth can be understood only during unfavourable market phases, and a fund history can validate that. Look for a fund that has a relatively longer fund history say 5 to 10 years. Compare fund performance across different time intervals and business cycles.

Suppose a fund has delivered a performance in line with the expected returns consistently during a market rally is a good one. Moreover, during a slump, if it lost 8% returns while the benchmark lost 10% returns, then the fund has done well.

Compare Fund Expense Ratio

Expense Ratio is the annual fee charged by the fund for managing your investment. As per SEBI guidelines, the fund houses cannot charge more than 2.5% of the fund’s average asset under management (AUM). You need to check the expense ratio of mutual funds before finalising on a given fund.

Expense ratios are charged out of the fund returns. So, the higher the expense ratio, the lower would be your take-home returns. Always look for a fund that offers similar returns at relatively lower expense ratio.

The same mutual fund is available as a direct plan and a regular plan. Direct plans of mutual funds come at a lower expense ratio; which translates into higher returns. Investing in direct plans of mutual funds, instead of regular plans, can save you loads on commissions.

If returns delivered by your expensive fund are not in line with the amount of fee charged, you may try passive investing as well. Look for index funds that fit your budget — these are relatively cheaper and deliver returns equal to the underlying benchmark returns.

Compare Risk-Adjusted Returns

Instead of looking at just annualised returns, look for risk-adjusted returns of the fund. As per risk-return tradeoff, a higher degree of risk should be compensated by a higher level of returns. The risk is measured with the help of standard deviation.

Using the Sharpe ratio helps to ascertain whether the fund is giving higher returns on every additional unit of risk taken. The fund having Sharpe ratio higher than the category average shows that the fund manager delivered higher returns for the extra risk taken.

Consider two equity funds A and B having a standard deviation, i.e. 12% and 15% respectively. If the Sharpe Ratio of A and B is 0.48 and 0.60, then go for fund B because it’s a better bet for the risk taken. However, if B’s Sharpe Ratio was around 0.50, then you could even have gone for A. It is because a mere 0.02 extra return isn’t worth it for assuming an extra 3% risk.

  You may compare the performance of different equity mutual funds against the benchmark index using the Sharpe Ratio. It helps you gauge the risk-adjusted return of equity funds. Sharpe Ratio may be used as a comparative tool to measure the performance of a mutual fund or a portfolio. It measures the excess portfolio return over the risk-free rate relative to the standard deviation of the portfolio return. Sharpe Ratio Formula: Sharpe Ratio = (Portfolio return – Risk-free rate of return) / Standard deviation of the portfolio. If two different mutual funds offer similar returns the one with the higher Sharpe Ratio has a better risk-adjusted return.

Sharpe Ratio	Inference
<1	Bad
1-1.99	Good
2-2.99	Very Good
>3	Excellent

Let us understand the Sharpe Ratio with an example. You are comparing two different equity funds called Fund A and Fund B to determine which has the better risk-adjusted return.

Parameter	Fund A	Fund B
Rate of Return	12%	10%
Risk-free rate of return	5%	5%
Standard Deviation	6	4
Sharpe Ratio	1.166666667	1.25

Sharpe Ratio = (Portfolio return – Risk-free rate of return) / Standard deviation of the portfolio. Sharpe Ratio (Fund A) = 12% – 5% / 6 = 1.1666. Sharpe Ratio (Fund B) = 10% – 5% / 4 = 1.25 Fund A has a higher expected return as compared to Fund B. However, volatility is also higher. Fund B has a higher Sharpe Ratio as compared to Fund A and has a higher risk-adjusted return. You may choose Fund B over Fund A as it has a higher Sharpe Ratio and a better risk-adjusted return.

Compare Average Maturity and Duration

These are essentially used to evaluate debt funds. Average maturity relates to the period after which the securities held by a debt fund will mature. The longer the maturity, the higher is its sensitivity to interest rate movements and higher are chances of a fall in the fund NAV due to a rise in interest rates.

Duration means how long does each underlying security of the debt fund take to reach a break-even point, i.e. point of no profit no loss. The shorter the duration, the quicker will it return your original investment. In such a scenario, you will be able to accumulate money to reach your goals.

While investing in debt funds, the average maturity and duration of the fund should match your investment horizon.

  You may consider looking at the average maturity of the debt fund before investing your money. It can be calculated using the maturity period of each security in the portfolio of the debt fund. You may find the average maturity expressed in days, months or years. Let us compare the average maturity of two different debt funds to understand the concept. Debt Fund A has three bonds in the portfolio with a maturity period of two, three and five years respectively. The amount invested in the two-year bond is Rs 40,000. It is Rs 20,000 in the three-year bond and Rs 30,000 in the five-year bond.

Bond	Maturity Period (Years)	Amount Invested (Rs)	Maturity Period * Amount Invested (Rs)
Bond 1	2	40,000	80000
Bond 2	3	20,000	60000
Bond 3	5	30,000	150000
Total	–	90,000	2,90,000
		Weighted Average Maturity (Years)	3.222222222

You would find the average maturity of bonds in the portfolio of the debt fund A as 3.22 years. Debt Fund B has three bonds in the portfolio with a maturity period of three, five and seven years respectively. The amount invested in the three-year bond is Rs 40,000. It is Rs 20,000 in the five-year bond and Rs 30,000 in the seven-year bond.

Bond	Maturity Period (Years)	Amount Invested (Rs)	Maturity Period * Amount Invested (Rs)
Bond 1	3	40,000	120000
Bond 2	5	20,000	100000
Bond 3	7	30,000	210000
Total	–	90,000	4,30,000
		Weighted Average Maturity (Years)	4.777777778

You would find the average maturity of bonds in the portfolio of the debt fund B as 4.77 years. Debt Fund B has a higher average maturity of 4.77 years as compared to 3.22 years for Debt Fund A. It is vulnerable to fluctuations in interest rates as it holds bonds of a longer maturity period. However. It could give you a higher return in a falling interest rate regime.

• The average maturity of the debt fund has an impact on the risk profile and overall return of the portfolio.
• You may find bond prices and interest rates moving in opposite directions. Moreover, bond prices are sensitive to the interest rate fluctuations in the economy. You find bond prices falling when interest rates rise.
• A debt fund which has many long-term bonds in the portfolio has a higher interest rate sensitivity, leading to fluctuations in the net asset value. It increases the risk of investing in the debt fund and you would find variability in return as compared to expected return.
• A debt fund with a longer average maturity is riskier as compared to a fund with a shorter average maturity. However, you may get a higher return from debt funds with a longer average maturity in a falling interest rate regime.

Macaulay Duration and Modified Duration of debt funds:

You may distinguish between debt funds based on the Macaulay Duration and the Modified Duration of bonds in the portfolio. Duration helps you measure the risk of investing in debt funds. Macaulay Durations shows you the time it takes for the price of a bond to be repaid through its internal cash flows. Modified duration shows you how much the NAV of a debt fund would change if interest rates move by 1%. Lets us compare two different debt funds to select the better fund based on duration. You have Debt Fund A with a modified duration of 5.7 years and Yield To Maturity (YTM) of 6.22%. You have Debt Fund B with a modified duration of 3.6 years and Yield To Maturity (YTM) of 6.45%.

	Modified Duration  (Years)	YTM (Yield To Maturity)	Expense Ratio
Debt Fund A	5.7	6.22%	1.15%
Debt Fund B	3.6	6.45%	1.15%

The modified duration of Debt Fund A is 5.7 years. It means if the interest rates go down by 1% then the NAV of the debt fund will go down by 5.7% and vice versa.

The modified duration of Debt Fund B is 3.6 years. It means if the interest rates go down by 1% then the NAV of the debt fund will go down by 3.6% and vice versa.

Debt Fund A is more sensitive to interest rate fluctuations as compared to Debt Fund B.

(Let’s assume interest rates have gone down by 50 bps or 0.5%)

Return from Debt Fund = YTM + Interest Rate Change * Modified Duration – Expense Ratio.

Return from Debt Fund A = 6.22 + (0.5 * 5.7) – 1.15 Return from Debt Fund A = 7.92%. Return from Debt Fund B = 6.45 + (0.5 * 3.6) – 1.15 Return from Debt Fund B = 7.1%

You would find Debt Fund A offering a higher return as compared to debt fund B if there is a 50 bps change in interest rates.

You may distinguish between debt funds based on the Macaulay Duration and the Modified Duration of bonds in the portfolio. Duration helps you measure the risk of investing in debt funds.

Macaulay Durations shows you the time it takes for the price of a bond to be repaid through its internal cash flows. Modified duration shows you how much the NAV of a debt fund would change if interest rates move by 1%.

Lets us compare two different debt funds to select the better fund based on duration. You have Debt Fund A with a modified duration of 5.7 years and Yield To Maturity (YTM) of 6.22%. You have Debt Fund B with a modified duration of 3.6 years and Yield To Maturity (YTM) of 6.45%.

Compare fund’s Alpha and Beta

Alpha measures the number of extra returns generated by the fund in excess of the benchmark returns. Beta measures the riskiness of a fund. Moreover, it shows whether the fund loses/gains more/less than the benchmark. If the beta value is more than one, it shows that the fund gains/loses more than the benchmark.

A beta value of one indicates that the mutual fund’s returns move the same as the benchmark. If the beta is less than one, then the fund gains/loses less than the benchmark. Consider two funds A and B which have the same level of beta, i.e. 2. If alpha of A and B is 2 and 1.75 respectively, then you may go for fund A. It’s because, for the same level of risk, the fund manager is able to generate higher returns than the benchmark.  

Compare Portfolio Turnover Ratio (PTR)

The portfolio turnover ratio tells you how often the fund manager buys/sells securities in the portfolio. In case of equity funds, it shows the level of trading taking place in the fund. You need to know that whenever an equity share is bought/sold, it attracts transaction charges like the brokerage. span>

Frequent trading going on in a portfolio ultimately increases the expenses and is reflected as a higher expense ratio. It might reduce your take-home returns from the fund. Thus, PTR is an important criterion for fund selection.

While choosing a fund, look for one with a lower PTR. If you want to go for a fund with a high PTR, then check whether such high PTR is being justified by way of higher returns.

How ClearTax can help you

Unless you are an active investor who closely follows the market trends and related metrics, it can be not very easy for you to choose a mutual fund according to the above parameters. ClearTax can help you here by handpicking the most suitable and best-performing investment portfolios for you based on your financial goals.