How to analyze a mutual fund?
There is no guided path to analyze a mutual fund scheme. You have to develop your method to do that. All of the small Investors like to focus heavily on the fund manager and the quality of stocks, picked by the fund manager some others like to look at only the historical returns. Hence, there are plenty of different plans in mutual funds so it is very important to analyze a mutual fund according to your financial goals before investing in it.
Here are 7 most common parameters to choose what’s right for you.
1. Expense ratio
Expense ratio is the percentage of total assets that an AMC charges to you as annually fee for managing your money. Higher the expense ratio, reduces the returns of your scheme. So, you should go for funds with lower expense ratio. Expense ratio consist of
- Distribution charges.
- Security transaction fees.
- Management fee.
- Investors transaction fee.
- Fund service charges.
The expense ratio reduces the returns of your scheme. So it is very important to look for scheme with lower expense ratio. Generally mutual fund schemes are categorized into – Direct and Regular Plans. Both these plans are exactly the same, as they both are managed by the same fund managers with the same stocks and bonds. The only difference is that direct mutual funds charge no broker commission and other charges. On the other hand, regular mutual fund schemes charge intermediary fees or commission. This commission is added to the expense or management cost of your scheme.
Therefore, you must compare the expense ratios of the different schemes before investing in one.
2. performance vs. benchmark performance.
How do you know whether a particular scheme has performed well or not? Each and every scheme has a benchmark, which it aims to outperform. You can compare the returns of a particular fund against its benchmark index.
Let’s understand that with an example.
Assume that a particular scheme gives 20% return in a particular year and you think, it’s good for you to invest in it. But at the same time period benchmark of the same scheme generated a return of 25%.
Now, reconsider that the particular mutual fund performed better or worse as compared to the benchmark?
Well done, you got it right. Here is benchmark index is performed better than particular scheme.
If a fund generates excess returns over the returns of the benchmark, then the quantum of excess returns is referred to as alpha of the scheme.
So you should compare the returns of a particular MF scheme against its benchmark index. It should outperforme.
3. Risk level.
In mutual funds Investment, risk and returns are two sides of the same coin. You can say that high return is associated with high risk also. Check risk associated with the particular scheme, it should fall within your risk appetite. Generally In mutual funds risk is categories as
- Low Risk
- Moderately low
- Moderately High
If you’re an investor with a low or moderately low-risk appetite, avoid high-risk funds.
4. Fund’s history.
The long-term performance is considered as the real test for a mutual fund scheme. A good scheme is one, which has generated consistent and stable returns over a period of 5-10 years. This gives the investors confidence that the fund can deliver returns, not only in the bull cycle but the bear cycle as well.
You should look at the history of the fund, Specifically, the performance of a fund over a period of at least 5 years.
5. Portfolio turnover ratio.
Portfolio Turnover Ratio means the frequency with which the fund’s holdings have changed over the past one year. It provides you an idea about the fund manager’s overall investment strategy. It helps you to understand the entire functioning of the scheme by looking at the PTR. You can check it in the monthly fact sheet of a scheme. However, there’s a simple formula which you may use to determine a fund’s Portfolio Turnover Ratio. It is calculated by dividing the lesser of purchases/sales by average asset under management (AUM).
Suppose the equity fund purchased ₹. 300 crore of equity shares. In the same year, it sold ₹. 400 crore of equity shares. The average AUM of the fund is ₹. 1200 crore. Hence, the Portfolio Turnover Ratio of the fund is 25%. It means that 25% or one-fourth of the assets of the portfolio were churned over the last one year.
By checking Portfolio turnover ratio of a scheme you can understand the strategy the fund manager is using to generate the return in your scheme. A low turnover ratio means buy and hold strategy. It shows the confidence of fund manager in his securities or stocks purchase. As a fund manager holds securities for a long time, it lower the expense ratio of the scheme. You should consider the category of a scheme when comparing PTR because it also depends on category of your scheme. For example the PTR of a passive funds like index funds, is low because there’s not much trading activity. The fund manager keeps buying and selling the securities to take advantage of the situation. High portfolio turnover means active strategy to generate high returns.
It is always advisable that consider expense ratio while analyzing a mutual fund along with return it provides.
6. Fund manager.
Hence what happens with your hard earned money in the particular scheme is depends on the fund manager. So performance, experience, history of the fund manager and other schemes that the fund manager is managing are crucial. This increases the reliability and confidence that your hard-earned money is in safe hands. Moreover, the reputation and history of the fund house, under which the scheme belongs can also be looked upon.
7. Exit Load.
This is the penalty charged by a fund house for leaving a scheme before a predefined time. Exit load normally ranges between 0% (for liquid funds) and 1% (up to 1 year of holding in an equity scheme). Invest in schemes with lower exit load or no exit load. Generally the exit load is charged, on the base of load structure applicable at the time of investment not at the time of redemption.
Putting all of the above factors together, you can add best mutual funds to your mutual fund portfolio.