How to analyse a Mutual Fund Performance?

Published On: 07-May-2020

One would have often read a standard disclaimer for investing in mutual funds, “past performance is not a guarantee for future returns.” This disclaimer tends to emphasise the fact that the historical returns generated by mutual funds may not be repeated in future periods. When one is investing in equity markets, one may not expect linear returns, and the returns may be volatile. However, the returns generated by mutual funds continue to be one of the most critical considerations by the investors. Here is how one must analyse mutual fund performance to make an informed decision in selecting the right mutual fund scheme.

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Performance against the Benchmark Index

One must analyse the performance of the mutual fund scheme against the returns generated by the benchmark index. SEBI guidelines make it mandatory for the mutual fund schemes to disclose the scheme performance along with the returns by the benchmark indices across different periods. Such performance must be considered for Total Returns Index (TRI) benchmark, which considers the returns through dividend and capital appreciation both. 

While the returns by the benchmark index may be reflective of the broader market conditions, the relative performance of a mutual fund scheme may help the investors to choose a better performing scheme. The additional returns generated by a mutual fund scheme over the returns generated by the benchmark index are referred to as alpha. A positive Alpha represents outperformance by the mutual fund scheme, whereas negative alpha represents underperformance by the mutual fund scheme. 

Long-Term Fund Performance

While one is analysing the performance of a mutual fund scheme, one must make such analysis over long term performance of the scheme. While the short-term performance may be skewed on account of exceptional reasons, whether adverse or favourable, the long-term performance takes into account the returns generated by the mutual funds over different economic cycles. 

Another alternate method to analyse the long-term performance may be to assign weights to different tenors, with higher weightage to the 10-year performance and such weights slowly decreasing as the period decreases. Such performance may then be compared against the benchmark indices as well as the peer category funds. 

Analysing the Key Performance Ratios

One must also analyse the mutual fund scheme on key performance ratios, including alpha, standard deviation, Sharpe ratio, etc. Standard deviation refers to the volatility in the fund performance, thereby reflecting the risk in investing in the mutual fund scheme. As such, the investors may choose the mutual fund scheme as per their risk appetite. 

For example, an aggressive investor may prefer funds with higher standard deviation, etc. However, such fund selection must also take into consideration the relative Sharpe Ratio. Sharpe ratio signifies the additional returns generated by the fund per unit of risk taken. A fund with a higher Sharpe ratio means better risk-adjusted returns for the investor. The investors may check such performance ratios from the fund factsheets available on the websites of the mutual fund houses.

Continuity of Fund Manager with the Fund

While the fund performance is imperative, the association of fund manager with the fund may also be necessary to correlate the returns with the fund manager. This is because the decision to invest in a mutual fund scheme is an indirect bet on the fund manager. As such, the investment performance of that fund manager may only be relevant for making such investment decisions. 

Expense Ratios

The performance disclosures made by the mutual funds are net of the expenses charged to the scheme. Thus, the expenses directly eat into the returns generated by the fund manager. As such, lower the expense ratio, better it is for the investors. Further, direct plans will always have lower expense ratios than the regular plans, thereby meaning higher returns for the investors in the direct plan. 

The investors must diligently analyse the mutual fund performance and make an informed decision to create a sound investment portfolio.