Evaluating the Correct Mutual Fund for Your Portfolio

How do you go shopping for the right fund? Here are the key factors to consider.

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There are more than 60 mutual funds that have yielded over 20 percent annualised returns over the last decade or so, not to mention of the 11,000 mutual funds that are available for subscription in India. In hindsight, it sounds easy to pick any fund and park your money, as there’s a general belief that mutual funds are the best instruments for wealth generation over the long term. While this is not entirely untrue, the trickiest part for any investor is to identify the right fund for his/her portfolio.

So how do you go shopping for the correct mutual fund? Here are the key factors to consider.

Fund house and manager pedigree

Before investing your money in a scheme of your choice, you must select the fund house carefully. Repose your faith on a money manager who has a sizable market share, robust presence in the financial market, and has schemes that have been running reasonably long with a consistent track record. A strong parentage ensures an efficient investments process, operational efficiency, risk management, and the capability to forge a strong sustained performance.

Risk

All investments are risky. Those that get you handsome returns carry more risk. It’s generally said that riskier the fund, the higher the earning potential. But this is a largely simplified view which implies that your returns are equivalent to the risk you take. This is not true in most cases because not all mutual funds are run well.

True measure of the risk is whether the fund is able to generate superior returns when the tides turn against the markets. There are several statistical techniques used for the purpose. A combination of risk tolerance and performance should usually go into rating a mutual fund. Hence, do not fall prey to generic four or five-star ratings that may imply only a high return performance as compared to its segment peers, but ascertain the risk adjusted return to make a wise choice.

Portfolio

The portfolio is perhaps the most important “intrinsic factor” of a mutual fund. By their very nature, mutual funds are supposed to diversify investments across various asset classes, stocks, bonds, sectors, and even geographies. A well-diversified portfolio carries a lower risk, compared to a fund which is biased towards an asset/instrument/security. Before investing, check the portfolio of the mutual fund for quality and weightages of various instruments to evaluate whether it is optimally diversified. The monthly portfolio of all schemes is available on the fund’s website, and are also available on several public domain financial websites.

Expense ratio

This ratio is the annual expenses incurred by a fund as a percentage of the average value of its net asset. While choosing between two or more similar types of funds, you have to factor in the expenses charged by them. A lower cost will benefit you in the long term. In most cases, the schemes that have higher assets have a lower expense ratio than a small-sized fund. As a fund grows in size, the associated fixed expenses are spread over more number of investors. This reduces the costs of running the fund, and there’s more money for investment.

Consistency

Would you park your money in an equity fund that gave more than 100% returns at a time when the markets are on a bull run but faced a sharp drop in its net asset value (NAV) when the markets became volatile? You surely wouldn’t want a fair-weather friend. A fund that consistently outperforms the benchmark indices for at least 3-5 years should be your cup of tea.

Sow the right seeds today…reap the sweet fruits tomorrow!!

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