Mutual Funds

5 parameters to check while comparing mutual fund schemes

Investors find it a bit difficult when it comes to comparing a scheme with another one. Among the many things, one should always check where is the fund managers are actually investing their money. Is it only debt, a combination of debt and equity or only equity? And in that too, in which ratio?

Among the other questions to ask is does the scheme fit into your objective and is it in line with your risk profile? Is the scheme is apt for you? And so on so forth.

Veteran investors have also accepted that mistakes do happen many times while selecting funds for making investments. However, one always learns from past mistakes. Let us understand these list of parameters through which one can compare and filter the mutual funds out of the financial universe.

First, evaluate the past performance of the fund manager with their respective benchmarks and check if they have performed fairly. Next, having done with the evaluation of the fund manager, check what is the broader investment style of the scheme. “It’s an important comparison point. Select the fund house and fund manager that has a strong presence in the financial world and provide funds that have a reasonably long and consistent track record. It ensures strong processes which are a combination of risk measures and operational efficiency,” said Samant Sikka, Co-Founder, Sqrrl Fintech Pvt. Ltd.

Understand the fund’s investment objectives

Every fund has its unique identity in terms of its investment style. A fund’s investment objective in creating a long-term capital appreciation is a key comparison point. Asset allocation, concentration of stocks (Top holdings) and sectors is an important parameter to avoid cannibalization amongst similar funds. Hence, the funds’ Investment style (Growth, blended or value) should also be looked into. Some of the strategies are:

–Value investing is an investment strategy where stocks selected trades for less than their intrinsic values.
–Growth strategy helps investors invest in companies that exhibit signs of above-average growth, even if the share price appears expensive in terms of metrics such as price-to-earnings or price-to-book ratios.

–Blended strategy offers investors diversification among value and growth investments in a single portfolio.

Hence, it is vital to understand your financial goal first and accordingly, you should invest in a fund which can help you achieve that goal on time.

Compare returns in a right way

You should try and watch the past performance of the fund. It is an important factor in analysing a mutual fund. But note that, past performance is not everything, as it may or may not be sustained in the future and therefore, it should not be used as the only parameter to select a mutual fund. “We have noticed that investors, and at times even advisors, tend to give maximum weightage to this parameter as it is pleasing for the eye to see good performance. We fail to see that future returns do not depend on this parameter,” said Angrish.

Sikka said that the time period over which returns should be compared and evaluated has to be the same over which that fund type is meant to be invested in. “If you are comparing equity funds then you must use 3-5-year returns. Short-term bond funds or liquid funds, on the other hand, is for a shorter time frame and will eventually be returned to you with a little something added. Comparing these on a shorter time frame (6 months) is fine,” he said.

Four risk parameters to check between funds

— Standard deviation measures the volatility of the returns from a mutual fund scheme over a particular period. It tells you how much the fund’s return can deviate from the historical mean return of the scheme.

— Sharpe ratio measures how well the fund has performed vis-a-vis the risk is taken by it. It is the excess return over risk-free return (usually return from treasury bills or government securities) divided by the standard deviation. The higher the Sharpe Ratio, the better the fund has performed in proportion to the risk taken by it.

— Alpha is the excess return of a fund compared to its benchmark index. If a fund has an alpha of 11%, it means it has outperformed its benchmark by 11% during a specified period.

— Beta which measures a fund’s volatility compared to that of a benchmark. It tells you how much a fund’s performance would swing compared to a benchmark. A fund with a beta of 1 means, it will move as much as the benchmark. If a fund has a beta of 1.2, it means that for every 10% upside or downside, the fund’s NAV would be 12% up or down.

Check for RANKINGS

There are various agencies which provide rankings to schemes by analysing several other parameters including the ones discussed above. These rating/ranking are given to scheme after doing intense research work.

“RANKING agencies tend to do a thorough background check and make recommendations. It’s a guidance point. One of these agencies, for example, ranks on a scale of 1 (indicating very good performance) to 5 and it helps one compare the right funds,” said Sikka.

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