Often, when we choose mutual funds, we check the past performance, and based on how they fared in the past, we make the decision. Is this enough? What other factors could be indicative of future performance? These are questions that you may have often pondered upon. Here we try to answer these questions which will help you choose the right mutual funds for investing.
Is it right to look at past performance?
The simple answer is Yes! From past performance one can estimate future returns of the fund, assuming market conditions are similar. However, it is not a guarantee that the fund will perform well in the future. Typically, when you are looking at mutual funds, you need to have tenure in mind, for example, if you are looking at equity mutual funds, you would come in with a long-term perspective. It is pertinent that you look at returns of 3 years, 5 years, and upwards. It is impractical to get swayed by the short-term underperformance or volatility that you may witness. Apart from the tenure, there are other considerations concerning looking at these past returns, here are some additional pointers that you need to consider.
- Risk-adjusted returns:
The risk factor of the fund is also of key importance, always look for funds which align with your risk appetite. The risk-adjusted returns simply mean how much additional return you gain by assuming a higher risk. It is important to note that the higher the risk, the possibility of return is potentially higher. However, there is no guarantee of a higher return. Evaluating return as a standalone factor could be detrimental, risk-return are 2 sides of the same coin, hence one needs to look at both these aspects together.
- Performance against index:
The performance of the fund should be assessed against the respective indices, you should look the for the outperformance of the fund vis-à-vis the index over the long haul. If the fund has consistently underperformed the index in the past, then that is indicative of some trouble brewing on the counter. Even during a downturn, the fund should be looked at in comparison with the index to see if the fund’s losses were lower than that of the index. It is apparent that irrespective of where you invest, the downturn is likely to affect your holding. Relative performance is what matters.
- Relative performance against peers:
The performance of the fund can also be compared against peers. The funds against which the comparison is being done should be of the same category, else the comparison would be futile. There are many fintech websites that offer sophisticated screeners, which already categorise the funds in accordance with their objectives. You should, however, wisely use them, in moderation to help you make an informed decision.
It is integral to note that past returns are not the only factor that helps us gain insight into the prospects of mutual funds. There are many other factors that should be considered before investing in mutual funds. Here’s a list of factors that you could consider.
- Fund manager’s experience and expertise:
The fund manager’s ability to weather the storm is critical to the performance of the fund. The outperformance of the fund as against the benchmark and its peers occurs due to the innate ability of the fund manager to pick the right stocks. You should look at the career graph of the fund manager and his ability to perform across various market cycles which will provide deeper insights into the prospects of the fund that you are considering.
- Past fund managers in the fund:
Typically, the fund manager managing a fund continues to do so over the long haul. However, it is not uncommon that a fund may change hands across fund managers due to continued underperformance or other reasons such as a fund manager moving to better opportunities. If the fund has changed too many hands, then you need to make a deeper assessment of the possible reasons for the same.
- Investment philosophy:
The investment objective of the fund is pertinent, it should align with your investment objective and risk appetite. It also gives a sense of the tenure with which you should invest in this fund.
- Funds resilience and performance during turbulent times:
The performance of the fund during turbulent times will help us assess if the fund is resilient enough to get back up and perform after any extreme loss situation. There were many funds that failed to get back on track after the 2008 crisis. This could essentially mean that the underlying stocks were unsustainable. The fund should try to invest in companies that have sustainable business practices which will enhance the ability of the fund to be resilient.
- Fee structure of fund:
Although this may not be the main criterion, you can look for funds that are competent on this front. The fee structure varies across categories, for example, index funds have the lowest fund management fee, however, they are passively managed. You should ensure to check funds within the same category.
6. Risk metrics of fund:
Risk of the fund is elaborately discussed in the scheme investment document, you can go through this to gain a deep understanding of the fund’s risk factors. There are many websites which enumerate the risk and score it on a risk-o-meter, you can align the risk of the fund with your risk appetite. There are many indicative performance measures such as Sharpe ratio which indicates the return premium per unit of risk. Other ratios such as alpha ratio indicates the excess return gained over the respective benchmark, the beta of the fund indicates the risk of the mutual fund as compared to that of the market. The market beta is always 1.
In conclusion:
Apart from all these factors, always remember to invest in mutual funds which align with your investment goals. Spend time, conduct thorough research, assess the risk, and invest in the fund that suits you best. You can always reach out to professionals at Tata Capital Wealth for assistance.
11 November 2022
6 mins read
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