Investing in mutual funds, here are 12 points to keep in mind

By: | Updated: November 23, 2015 12:43 PM

The presence of a number of mutual fund schemes in the market makes it a challenging task for an investor to identify a handful of schemes from this large universe.

mutual funds investmentIn the final analysis, mutual funds are the best route for individual investors to gain access to equity or debt as asset classes, provided they have exercised all the due diligence. (Express Photo)

The presence of a number of mutual fund schemes in the market makes it a challenging task for an investor to identify a handful of schemes from this large universe. While there are innumerable macro-checks and micro-checks one needs to run before arriving at the perfect match for one’s needs and reap maximum benefits.

Nityanand Prabhu, COO, LIC Nomura MF,  said, “In order to achieve a winning performance of mutual fund portfolio, prospective investor should look at both quantitative and qualitative parameters. With over 2,185 mutual fund schemes offered by distinct 44 domestic mutual fund houses available in the market, picking up right schemes can be a difficult task.”

One should look at the following broad 12 points in order of priority while selecting a mutual fund scheme:

1) Investment objective of fund: This is the most crucial step before taking an investment decision. The investment objective states the scheme’s goal and investment rationale. It specifies where your money would be invested i.e. debt, equity, gold or a blend of all. It is imperative to read this section carefully to ascertain if your investment objective and the risk profile are matching with that of the scheme. For instance, if you’re seeking capital protection or long term capital appreciation, this portion would tell you how it endeavors to achieve this goal.

2) Select the right fund house: An investor must analyse as to what kind of a reputation does a fund house have in which he is going to invest and what is the total corpus under the management of the fund house. How the other schemes of the fund house are performing, what rank does the fund house have among the all fund houses?

Jimmy Patel, chief executive officer, Quantum AMC said, “Choose an AMC whose business and investment philosophy is appealing to you. Check on how the majority of their schemes are performing. Understand if the fund house is investor-centric, or only profit-centric. Don’t go for big AMCs. Just because it is big doesn’t mean it is right for you.”

3) Fund manager experience, track record and consistency: An investor should then analyse as to who is managing or going to manage the fund. The person who manages the fund is called the fund manager. An investor must see the profile of the fund manager, his educational qualification, past experience and the performance of other schemes managed by the same fund manager. “One has to see that how many schemes a fund manager is managing alone, an investor should compare the returns of the schemes (manages by the same fund manager) with the similar kind of existing schemes in the market by different fund houses, said DK Aggarwal, chairman and managing director, SMC Investments and Advisors.

Shankar Raman, CIO, Third Party Products, Centrum Wealth Management, said, “The fund management business justifiably attaches a premium to experience. Apart from this, it is useful to know if the performance across periods of the fund manager and the fund in question has been consistent – for self-driven investors, consistency may be more important than volatile performance, in the absence of an ability/keenness to actively monitor fund portfolios and behavior. And remember, performance should be evaluated across both return and risk.”

4) Asset Under Management: One should carefully assess the Asset Under Management (AUM) of the scheme, which a fund manager is managing. “The AUM of the scheme should not be less, as a fund manager may loose opportunities and it should not be too high, in which case he may not be able to utilise it properly. In brief, a fund asset under management should be of an average size,” said Aggarwal.

Arun Gopalan, vice-president, Systematix Shares & Stocks, said, “An investor also check the focus of the AMC. Many AMCs, by virtue of their pedigree, or by virtue of their investment philosophies, tend to focus on a particular asset class. Some AMC focus on Debt Funds, as its sponsor company could be a global bank, which specialises in debt. Others may focus on equity products. Do not opt those funds of a fund house, which they are not focusing on.”

5) Asset Allocation: An investor should further look at the asset allocation of the scheme. The portfolio of the fund should be totally diversified, this reduces risk. But a portfolio should be diversified to some extent. Over diversification may however increase the cost of churning of the portfolio, though it is good from the safety point of view but will reduce the returns generated by the scheme.

Although past performance is no guarantee of future performance, it is useful to assess how well the scheme has performed in relation to its benchmark and the stated objective. An investor should keep an eye on the benchmark returns of the fund and compare the benchmark returns with the scheme return. A comparison of scheme return with the benchmark return is the best way to know the performance of the fund. Then an investor should compare the returns of the fund with similar kind of fund existing in the market of different fund houses.

Jimeet Modi, chief executive officer, SAMCO Securities, said, “It is essential to check the track record of returns that have been delivered and whether the returns have outperformed the benchmark indices. It would be fruitful to understand how the investment decisions are arrived at whether it is team based and process driven or individual decision of the fund manager. Team based system driven decisions are a prudent way of making investments but if the decisions are based on an individual fund manager’s intellect than checking the track record of the fund manager is of utmost importance.”

Gopalan said, “Avoid funds which are highly volatile in their returns. Funds which fall greatly when markets fall can lead to huge value erosion and the fund manager may have to take risky bets to earn to cover the loss. Funds with very high Beta (volatility with respect to the Index) had better be avoided.”

6) Risk Analysis: While NAV return is important, one area that should never be ignored by an investor is “the risk involved while investing in the fund”. Mutual funds being market-linked are prime candidates for stock market related risks. Two aspects that investors should take into account are volatility of the fund as indicated by the Standard Deviation (SD) and risk-adjusted returns as calculated by the Sharpe Ratio (SR).

D Ramanathan, head, sales and marketing, Shriram AMC said, “Many a times investors choose a scheme based on their near term performance ignoring the long term trend and the underlying risks. The need to understand the behavior of individual asset classes is essential for successful investing. For example, if you have a horizon of 2 years, Debt funds with a shorter portfolio maturity are highly suited for such shorter time frames. In addition, risokmeter printed on the scheme application helps decipher the degree of risk of a scheme such as low, moderately low, moderate, moderately high and high.

7) Tax Implication: Generally, investors go by the recommendation of their mutual fund distributor, agent or relationship manager as the case may be and invest in mutual fund schemes without evaluating the tax implications of such investments. Prabu said, “It is necessary for investors to be aware of the tax implications of a respective mutual fund schemes, in order to be tax efficient and to avoid and tax surprise.”

For ex: equity schemes, debt schemes and gold schemes have different tax treatments.

Mutual fund schemes, say it debt or equity enjoy better tax treatment and offer superior post tax returns. For instance, investing in Equity linked tax saving scheme qualifies under section 80C where one can save up to 1.50 lakhs in a financial year. Dividends are tax free in the hands of the investor and the long term capital gain tax is also NIL.

Siddhant Jain, co-founder, Wealth Force, a mutual fund brand by SAS Online, said, “As an investor, one should always consider returns post tax for comparison. Investments in Equity Linked Savings Scheme (ELSS), also known as tax saving mutual fund is deductible from taxable income (upto 1.5 lakhs under Section 80 C). Any return from a normal equity fund is also tax free if the investment is more than a year old. Debt Funds however attract tax, the rate depending upon the tenure of the investment.”

8) Choosing the right option in a scheme: A mutual fund scheme usually has three investment options: Growth, Dividend Reinvestment and Dividend Payout. Selecting the right option is extremely important as it can really affect your overall return. In the growth option, you will not get any returns or dividends during the period of the investment. Your net returns will be when you redeem your units. As compared in the dividend option, you will receive returns at periodic intervals in form of dividends. Further you can choose to either receive these dividends or get them reinvested in the fund. “The growth option stands out as the best option as it truly leverages the power of compounding to give maximum returns,” said Jain.

9) Charges: Do consider this cost before you invest. There are primarily two types of charges that an investor should keep in mind before investing in a mutual fund. Exit Load is the fee charged by the fund from the investor upon redemption, which eats into the investor’s net return. Usually most funds have an exit load (1 per cent) for redemptions within 1 year. The other charge, expense ratio is the annual fees, which is charged by the fund for its management and administrative costs. When the market is in a downturn, a higher expense ratio further drags down the fund performance. Hence, always prefer a scheme, all other parameters being equal, with a lower expense ratio (typically for equity funds, it varies between 2-2.5%).

As an investor you should also pay attention to the expense ratio of the fund. Expense ratio is the measure of what it costs an investment company to operate a mutual fund. Remember, higher the expense ratio, larger the portion of your money that is deducted as fee by the AMC, therefore this is something that affects your final returns.

“For very long term investments even a difference of 0.5 per cent in expense ratio can translate to lakhs in rupee terms. A good fund house will attempt to maximize your gain by keeping costs as low as it can,” said Jimmy Patel, chief executive officer, Quantum AMC.

10) Don’t time the market: This is one of the common mistakes investors do while investing in equity funds. “Time in the market is more important than timing the market. It is almost impossible to catch the bottom and peak.  Although markets are difficult to predict in the near term, over long periods of time market tend to be rationale and evaluations be efficient. Hence, it is highly recommended to approach equity investing with a long term horizon of 3 – 5 years. SIP is one of the most time tested strategy as it helps inculcate disciplined investing and the benefit of rupee cost averaging,” said D Ramanathan, head, sales and marketing, Shriram AMC.

11) Fund ratings: It is very important to do our ‘own’ homework when our hard-earned money is at stake. While there is really no substitute to this, assuming you are not advised by a professional advisor, you could look up fund ratings by various agencies purely as a second opinion. “The caveat here is that fund ratings change quite substantially even over short periods – so this is only a last checkbox you could tick before deciding,” said Shankar Raman of Centrum Wealth Management.

12) Disclosure Transparency & Investor Service: Services offered by mutual fund houses may vary across funds. Some fund houses are more investor friendly than others, and offer information at regular intervals. “Regular information dissemination helps investor analyze their portfolio for taking an informed decision. Thus while investing, it is important to examine a little detail and assess whether the fund house and the respective mutual fund scheme adopts good disclosure norms, thus making investor exude confidence in them and take a prudent investment decision,” said Prabhu of LIC Nomura MF.

In the final analysis, mutual funds are the best route for individual investors to gain access to equity or debt as asset classes, provided they have exercised all the due diligence as mentioned above. Gopalan of  Systematix Shares & Stocks, said, “In my opinion, one should necessarily engage the services of an experienced advisor to get the best funds to work to your  financial plan.”


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