Analyse performance: One should look at performance of at least 5 years. One good way to measure performance is using a quartile methodology. The approach here is to categorize funds in 4 quartiles, like a forced ranking method. The top performing funds are in the 1st Quartile and worst funds are in the 4th quartile. This helps us to identify funds which relatively do better than others. Quartile methodology can also be applied to other parameters like risk behaviour, total expense ratio and so on. One should also consider the risk behaviour and not just the performance.
Review Portfolio composition: This can vary among the funds in the same category. As an example, in the Large Cap funds category as on 31-May-2014, ICICI Prudential Top 100 has about ~83% and DSP Blackrock has ~90% exposure to Large Cap stocks. Some funds may change the composition frequently. You need to be comfortable with the quality of the debt paper in a debt fund, as an example. The sector concentration, exposure to a particular company and market capitalization are the areas that should be reviewed carefully. .
Check the expense ratio: Now, Equity Mutual Funds are mandated to cap their expenses to 2.5%. Debt funds have lower expense ratio. Index and Liquid Funds are very low cost instruments. So carefully review the expense ratio of the funds under consideration. Should one reject a well performing fund because it’s expense ratio is highest? Well, that’s not recommended, just like one should not select a fund just because it’s expense ratio is lowest. One should look at all parameters and then take an overall call.
Fund Manager: So there is this debate of process driven approach of investments and hence no or low dependency on a specific fund manager. The rationale for an actively managed fund is the alpha that the fund manager adds. In a growth oriented economy like India, there is certainly a case for actively managed funds & hence the fund manager does play a significant role. Like one should not blindly trust a fund manager just by his big name, one should also not overlook this factor. The tenor of the fund manager, track record and no. of schemes that he or she manages are an important consideration.
Rating: Should one be influenced by the rating of the funds on the popular websites? Going blindly by the rating may not be a good idea. The fund objective and style has to match your goals and risk tolerance. Every research house has a different methodology and they may or may not have subjective elements. Hence the same fund could be rated differently at the same time. One good way to avoid any biased decision here is to take deeper insights and consider all factors mentioned above and not just the rating.
Other factors: One can check Assets Under Management (AUM) Size and Alpha. Check the trend in the funds AUM and see if you are observing any disturbing trend(s). If you get data on the Alpha i.e. value added by the fund manager, then you can check how the fund manager has performed in the high return and low return days.
Data source: Where does one get this kind of data? Websites like www.valueresearchonline.com, www.moneycontrol.com and www.morningstar.in provide lot of data for analysis. One may get better insights with a paid research services offered by various research companies. It may be a good idea to review at least two sources. Leading personal finance blogs may provide another source of analysis.
Sometimes funds look similar so un-selection and not the selection becomes a challenge. In some cases, the fund selection can still turn out to be a judgement call. The objective here is to use a methodology and try to use as many quantified parameters as possible. One should ensure a goal based investment and leverage SIP approach for better results.
This article was originally published on Moneycontrol.
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