Parameters to Analyse Mutual Fund Performance

Published On: 23-Apr-2019

Just as it is important to make the right investments, it is equally essential that you review them on a periodical basis, to ensure that they continue to perform in line with the markets and your expectations. A periodical review of your mutual fund investments may help you to replace the underperforming mutual funds with better schemes. If you are also thinking about how to track mutual fund performance, this article aims to share key ratios to help you analyse the performance of your mutual fund schemes. Mutual fund fact sheet may help you get key information about your fund and its performance.

Parameters to analyze mutual fund performance


Here are six critical parameters against which you may measure your fund performance:

1.    Fund performance against its benchmark

As per SEBI guidelines, the mutual fund schemes need to be benchmarked with an acceptable index and the performance must be compared with the benchmark index, where ever such performance is being disclosed. As such, the investors must check if the fund has been underperforming or outperforming its benchmark. The benchmark performance tends to reflect the broader market performance as also suiting the scheme allocation. So, if the fund has underperformed the benchmark consistently, it is time for you to replace it with a better performing fund.

2.    Long term returns

Mutual funds need to disclose the 1-year, 3-year, 5-year & since inception returns for the schemes. While the investors may get excited with the strong 1-year returns, the performance review should ideally capture the long-term returns, since that may be a better reflection of the long term investing decisions.

3.    Risk-Adjusted Returns

The investors tend to make their investment decisions based on the returns so disclosed. Risk-return trade-off generally implies that higher the risk is taken, higher should be the returns, but it assumes importance also to check if such returns are coming at the cost of much higher risk. As such, doing some number crunching with statistical ratios like Sharpe Ratio, Standard Deviation, Credit Profile etc. may help you get a better sense of risk-adjusted returns.

Standard deviation helps to judge the risk of the mutual fund scheme, in terms of volatility in the returns. Sharpe ratio helps you to ascertain the returns of the fund on every additional unit of risk taken. So, the fund with a higher Sharpe ratio as compared to the category average reflects that the fund has generated higher returns for the extra risk taken.

4.    Alpha & Beta

Alpha represents the outperformance of the mutual fund scheme, as compared to the benchmark returns. Beta reflects the sensitivity of the mutual fund portfolio as compared with the benchmark index. If the beta value is more than one, it reflects that for every single point movement in the benchmark, the fund value is likely to move greater than such movement. As such, a fund with a beta higher than 1.0 must have a positive alpha. A higher alpha tends to reflect on the fund manager’s ability to generate superior returns. So, if two funds have a similar beta, you must choose the fund with a higher alpha, since the fund manager has been able to generate better returns for a similar risk.

5.    Average Maturity and Yield

While the above-discussed ratios may be suitable for equity schemes, debt schemes need to be analyzed with respect to average maturity and yield. Average maturity refers to weighted average of maturities of all debt instruments in the fund portfolio.  A longer maturity of the debt fund results in higher sensitivity to the interest rate movements. As such, the performance of debt funds, especially long duration funds, must also be seen in the light of the past and expected monetary policy actions.

6.    Total Expense Ratio (TER)

TER refers to the total expenses being incurred by the mutual fund scheme, including fund management charges, selling and brokerage expenses, etc. Since mutual funds act in a fiduciary capacity, the related expenses are also recovered from the investors only, as a deduction to the fund returns. For example, if your fund generates 16% returns and the TER is 2%, the NAV (Net Asset Value) of the fund would have grown by 14%, reflecting the returns for the investors. Further, active funds tend to have a higher expense ratio, on account of higher fund management charges, which are marginal in passive funds and ETF (Exchange Traded Fund). As such, if an active fund is underperforming the benchmark, it makes sense to consider investing in index funds, which are relatively cheaper and deliver returns equal to the underlying benchmark returns.

With the above considerations, the investors must make an informed decision in their journey of financial planning.