1. How to evaluate mutual fund performance
a. Define the investment goals
What is the purpose of my investment? Answer to this should be the foundation of your mutual fund choices. For instance, if you want a regular income with capital protection, you can choose to invest in a debt fund. But if you have a higher risk appetite and an aim to build your wealth, equities will suit your purpose. So it is important to define your financial goal first and then decide your investment. This also has a crucial role in fund evaluation.
b. Shortlist a few peer funds to compare
It is difficult to assess a mutual fund in isolation. So, you should always make a small list of comparable funds and constantly compare them. There are many Fintech firms and third party websites that offer free mutual fund screener tools.
c. Check the historical performance data
Now every mutual fund handbook comes with a disclaimer stating that past performance is no indicator of future performance. However, these data can help you check how the fund has fared across different market cycles. Consistency can also shed light on the skill of the fund manager. In short, it will be easier for you to find a fund with lower risks but higher returns.
d. Fee structure of the fund
A mutual fund company charges you for its services and expertise. Some funds require deft management and quick decisions on whether to buy, sell or hold on to an asset. Please remember that a fund with a higher fee is automatically better. Do check out other parameters too before choosing.
e. Risk-adjusted returns
Every fund expects certain risks, related to the market and the industry. When a fund strategizes in such a way that they make more returns against expected risks, we call them risk-adjusted returns.
f. Performance against index
Indexes like Nifty, BSE Sensex, and BSE 200 set benchmarks, and all fund performances are evaluated on this basis. Comparing over different timelines against the benchmark as well as peers can be insightful. A well-managed fund won’t fall too hard during a market low.
2. Why track the investment performance
You might have seen the disclaimer that ‘past performance does not indicate the future performance of a fund’. It means that you cannot expect guaranteed returns on investment. Therefore, you need to look beyond the previous years’ returns to assess a mutual fund. Primarily, you should monitor your investments so that you can make informed decisions that can lead to higher returns.
You know that the capital market keeps fluctuating with changes in the overall economic conditions. Such a change disturbs the asset allocation of the portfolio. For instance, an original allocation of 50:50 in equity & debt may change to 60:40 owing to a market rally. It may increase the risk profile of the fund beyond your requirements. Fund evaluation also helps you to compare the performance of your investment against other similar funds. Additionally, a change in fund manager or fundamental attributes of your fund may also trigger an evaluation. Hence, a review and rebalancing might be required to keep the risk profile of the portfolio intact.
3. How often to evaluate fund performance
Market is subject to fluctuations. However, that doesn’t mean you need to assess the fund performance on a daily basis. Ideally, you should evaluate your fund every six months to a year depending on the tenure of the investment. Evaluating the funds in a shorter period does not give an accurate insight into the performance of your investments. If all this sounds too much, you may invest in regular funds. As qualified intermediaries, they advise you to invest in funds based on your financial goals and risk profile.
4. Financial ratios & fund performance
While you may have taken due diligence and advice before investing, you still need to track the performance of your funds. The easiest way to do it is by using the Fund Fact Sheet. In simple terms, fund fact sheet shows the performance of all the schemes managed by your fund house including your investment. It is essential that you compare these financial ratios with the mutual fund schemes in the same category to understand where your fund stands.
The fund’s Alpha gives an overview of the fund manager’s skills and strategies, and how they fared in the past. It should always be higher than the expense ratio of the fund. Additionally, your fund’s alpha needs to be higher than the peers which are at the similar level of beta.
b. Expense ratio
This is essentially the fee for the fund house for managing your mutual fund. Expense ratio reflects the value-for-money aspect of a fund. It consists of fund management charges and all the other costs related to fund management. It impacts your ultimate take home returns.
It is always advisable to compare the fund performance against the benchmark. The benchmark acts as a standard for funds’ performance. If your fund is outperforming the benchmark consistently, it is a sign that the fund is doing well. You can also compare the average return during a specific time frame with its peer funds in the same category.
d. Portfolio holdings
Look for considerable changes and probable overlapping in the portfolio holdings. The fund needs to hold good quality stocks which have a lower Price to Earning-per-share (P/E) Ratio vis-a-vis Price to Book Value (P/B) ratio. Additionally, ensure that the fund is investing as per its investment objective. For instance, fund having a high portfolio turnover ratio vis-a-vis lower returns is a bad indicator.
e. Sharpe ratio
This ratio shows how much extra return you receive for the additional risks you undertake. It is a rule of thumb that higher risks must be compensated more. And you too deserve a reward (extra returns) for the added volatility. Sharpe ratio tells you how much exactly should be that reward.
In short, consistency says a lot about performance. If you think that doing all this research and analytics is beyond you, you can always invest with ClearTax Save. With hand-picked funds from the top fund houses in the country, you are in safe hands.