How to choose a Mutual Fund?

Published On: 19-Dec-2021

With a wide range of mutual fund schemes are available for investments, it becomes imperative for the investors to carefully review the available options and then select the mutual fund schemes best suiting the risk profile, financial goals, and investment horizon. Different mutual fund schemes may be suitable for financial goals with varied investment horizons.

For example, equity funds may be suitable for achieving one’s financial goals as they are potential for generating higher returns over the long-term, however may not be ideal for short-term goals for their nature of high-volatility. Similarly, debt funds may provide stable and reasonable returns, therefore they are useful for planning for emergency funds, short-term goals. However, while an investor may shortlist specified mutual fund categories suitable to them, selecting a specific mutual fund scheme within that category also becomes crucial.

Here are five considerations for an investor to choose the right mutual fund scheme:

Performance of the fund against the benchmark index

As per SEBI (Securities & Exchange Board of India) guidelines, mutual funds must disclose the fund performance across different periods in the specified format. Along with such performance, the returns generated by the benchmark index are also required to be disclosed.

One may review the fund performance against the benchmark returns to check the alpha generated by the fund, which denotes the excess of fund returns over the benchmark returns.

While the investors should note that historical returns is not a guarantee for future returns, however, it can help the investors to have a comfort in the fund's based on the investment strategy that is followed in the fund. One can access performance details of the fund and the benchmark index in the monthly fund fact sheet shared by the fund house on its website.

Fund performance under the current fund manager

The fund managers, primarily drive investment decisions for active funds. It makes sense for the investors to review the fund performance under the current fund manager only. In case the fund manager has recently been appointed for the scheme, one may like to review the alpha generated in other schemes managed/being managed previously.

Risk profile of the Scheme

Not only does the fund performance matter, but it also matters whether the fund has generated returns commensurate with the risk undertaken in the portfolio. In simple terms, one should aim to review the risk-adjusted returns of the scheme.

If similar returns have been generated by two mutual fund schemes, a fund with lower risk should be preferred. The risk profile of the mutual fund scheme can be gauged by looking at the portfolio concentration, standard deviation, sharpe ratio etc., of the fund. The statistical ratios of standard deviation and sharpe ratio provide an objective criterion for fund comparison to investors. The investors can check the fund ratios in the monthly fund fact sheets.

Portfolio Concentration

Whether it is an equity fund or a debt fund, portfolio concentration throws greater light on the fund manager's investment strategy i.e., return generation potential given the riskiness of the fund.

The scheme portfolio is shared in detail by the fund houses on their websites and disclosed in the monthly fund factsheets. Further, a fund with high portfolio concentration may carry higher-risk, especially for debt schemes, if there is an event of default or credit downgrades in a security, may wipe off significant returns for the investors and leading to negative return outcome.

Investors may also diversify their investments by choosing to invest in funds with differentiated strategies across the asset class. This will help in reducing the risk of excessive portfolio overlapping and concentration.

Risk Appetite of the Investor

It is also crucial for the investors to align their risk appetite with suitable to fund. For example, an investor may have shortlisted a small-cap fund but is not comfortable with short-term volatility. In such a scenario, the shortlisted scheme should be screened out, and instead, such mutual fund schemes may be considered which match the investor's risk profile.

With the above parameters into consideration, the investors must make an informed decision to pursue their financial goals.