How to Select a Mutual Fund?
Choosing The Best Mutual Fund
Mutual Fund is a good investment instrument to meet one’s financial goals with their ease of investing and professional management. However, mutual funds vary in terms of their objectives, investment horizon, AUM, charges and past performances.
Selecting a mutual fund for investing is a very important step. It is difficult to figure out which fund will do well in the future and give you returns that beat industry peers. Understanding on how to select a mutual fund can be difficult task given the number of schemes in the market. However, if you follow a few basics while choosing the fund, chances are you might end up getting decent returns on your investments.
Having an investment goal
- Selecting a mutual fund for investing is not only an important but also a crucial step. However, it is the second step and not the first one. The most important and the first step for any investment is to have an investment goal. A fantastic fund selection without having an investment objective is useless. One should know the reason for the investment and the time horizon (how long one can be in the investment) before making the first investment.
- If you are looking for a longer term investment, which means you are looking to be invested for at least 8 to 10 years. Thus, It indicates you are looking to invest in equity mutual funds.
- Asset Allocation : Your focus – Investment goal & time horizon, will lead you to the correct asset allocation. Asset allocation is a very important factor which will decide how much money you are going to put into an equity fund.
- Once you have determined your asset allocation, the next step is- how to choose the right mutual fund scheme to invest in?
- Therefore, selecting the right equity fund is important. Analyzing qualitative and quantitative parameters can help you pick the right fund. In this article we discuss steps involved to do the same.
picking right equity fund category
Picking the right fund category is important before you turn towards qualitative and quantitative parameters. Equity oriented hybrid funds are a good choice to achieve goals which are more 3-5 years away and pure equity funds for goals more than 5 years away.
- Within pure equity funds there are various types:
Above are ideal investment vehicles to achieve goals with said duration.
- Other aspects that impacts the category of fund you ultimately pick is, your financial position and your risk profile.
i. Financial position:
You can achieve the same goal by selecting any of the categories defined above, but with each category the amount required to be invested will vary. Large cap funds would require a higher investment amount than mid cap funds to achieve the same goal. So, you could go for any category if have the financial capacity to fund the amount. But if you don’t have the capacity, you will have to a pick higher risk category to achieve your goal.
ii. Risk Profile:
You may not be very comfortable with higher risk involved with investing into small cap funds, but can have good night’s sleep with stable large cap funds. So, based on this comfort level of yours, you could select a lower risk category, but remember the amount to be invested will be higher.
So, select an equity fund category based on the duration of investment, your financial position and your risk profile.
choosing the right scheme
There are thousands of schemes to choose from. Once you have finalized the fund type, you should consider following factors to finalize which scheme suits you the most:
1. fund house pedigree :
- When you are going to invest in a mutual fund, you are trusting the fund house to manage your money. This is why the pedigree of the fund is important. Decisions taken by the fund house and the fund manager may have a direct impact on your investment’s performance and the realisation of your financial goals.
- Hence, before selecting a scheme, it is important to do a check on the fund house, history of existence, overall long-term performance, their compliance record etc.
- This criterion will help you remove few fund house schemes from further selection.
2. historical performance :
- The most important criterion for selection of the scheme. You should choose the scheme which has a very good long-term record both against benchmark and peers.
- It is true that historical performance is no guarantee of future performance, but it gives a good pointer. We recommend you go for funds which have consistently outperformed their benchmark index and peers over medium-longer terms (3, 5 and 10 years).
- Equity mutual funds are conducive for long term investments only. Thus, the focus should be on long term performance than a weekly, monthly or quarterly performance. You can find these details in mutual fund factsheets.
3. Fund manager :
The credit for outperformance or underperformance of a mutual fund scheme lies with the fund manager (and his research team). You may not want to invest in a scheme with a new Fund manager. With most of the fund houses following strict investment process and guidelines, new fund managers mostly cannot create too much flutter and therefore you should keenly observe the performance before taking any investment or redemption decision. So, while selecting the scheme, you should look for the following info:
- If the fund manager is a new recruit, how has been his/her performance with past schemes?
- How are the other schemes performing which are managed by this fund manager?
- How long the current Fund Manager is working with the scheme and how has been the performance during his/her tenure?
4. ket ratios :
You and your advisor should also consider few ratios before selecting an Equity Fund scheme:
- Beta – Measures volatility. A beta of more than 1 (say 1.25) means that the fund is more volatile (25% in case of fund with Beta = 1.25) than the market. A lower beta indicates that the fund is more stable than the index
- Alpha – Measure of how much the fund has outperformed its predicted return (Beta dependent). Look for higher alpha.
Net assets of any scheme gives a fair idea of the confidence level of investors in the mutual fund scheme. Fund houses deploy their best fund managers for mutual fund schemes with high AUM. Therefore, this could be used as rejection criterion. You should reject the schemes with very low AUM as their volatility, expenses and risk profile could be higher.
6. expense ratio :
You should avoid schemes with very high Expense ratio. You should choose a scheme with average or below average expense ratio. Most of the established fund schemes will have lower expense ratio. Average Expense ratio of Equity funds (based on type) is between 1.8-2.2%
7. exit load :
There are few funds which charge very high Exit load as high as 3%. Though Equity fund investments are for long term but still you should avoid very high exit load funds as it kills your liquidity and ability to switch out in case of non-performance.
8. fund ratings :
We have provided unique ratings to each and every equity fund on our portal. You can refer to their ratings before finalizing the scheme to invest. Or you can even refer the ratings provided by third party agencies such as Value Research, Morningstar, Crisil etc. But, don’t over depend on these ratings as they can be quite confusing as everyone has their own way of ranking mutual funds. But good ratings on your final shortlist or shortlist given by your advisor are a good confidence booster.