Let?s say you feel the need to dabble in equities now that the markets are finally showing prolonged signs of recuperation. But still, despite the Sensex having scaled the 17k mark again, direct equity investments pose a risk that you just can?t handle. So you turn to equity-oriented mutual funds. To choose a fund to invest in, you would probably log on to ValueResearchOnline.com or a similar website and check out the returns generated by equity funds in the past months. The fund that has generated the highest returns in the past six months or one year would be the ideal pick, right? Well, not really.
The returns generated by a fund should be just a starting guide. The top performing diversified equity fund in the past one year has generated returns of 67.05 %. The fund that comes next in line has earned 64.77 %. On the same lines, of the 215 diversified equity funds that have been around for at least six months, almost a hundred of them have six-month returns in the range of 75 %. Those on the top of this ladder have generated returns in the range of 119 %. The difference between 75 and 119 is much bigger than the one between 64.77 and 67.05, but as far as investment decisions are concerned, this difference is irrelevant.
Of course, if you had invested in the top performing fund, you would certainly be richer than if you had invested in the 100th fund. But when it comes to choosing a fund, just the returns generated are not enough to base your decision upon. Simply because, past returns are no guarantee for future potential. Past performance is important, it is one of the few pieces of hard data that an investor has at his disposal. However, past performance is mostly relevant only when seen in conjunction with difference time periods. There are good funds, average funds and bad funds, and most often no fund remains in the same category for a long period of time.
So what does an investor do? How does he pick a fund to invest in? To ensure that the choice you make is the best suited to your needs, you need to dwell deeper and go beyond just recent returns. Find out how the fund fared in a market downturn in comparison to others in its category. Check how much of its losses it recovered and how much time it took in recovering these losses. Another important aspect is how the fund is performing vis-?-vis its benchmark and other market benchmarks.
Of course, the answers to these questions will also be returns-like numeric ones, but when taken into account together, they provide the best means of making an investment decision. For example, a fund might have generated astounding returns in the past few months, which makes it sound like a good investment. But after probing further you might discover that it languished at the bottom during the downturn, which makes it a very dicey investment.
An investor has no means of predicting the exact future of a fund, but a deeper analysis on these lines is enough to separate the good ones from the bad.
?The author is CEO of Value Research
