BASIC KNOWLEDGE BEFORE SELECTING MUTUAL FUND

Mutual Funds Industry today is one of the most preferred investment options all over the world. Since several mutual fund schemes are available in market it is very difficult for an average investor to select the right mutual fund. There is danger in choosing mutual fund on its past performance or returns & if you make the wrong choice you could lose money or could not achieve your target or purpose for which you have invest in Mutual Fund. So how do you go about selecting the right mutual fund?

  1. Investment objective, Time Horizon: Each fund have its own logic of investment & targeted customers. You should try to match the objectives and investment philosophy of mutual fund, with your investment goal & time horizon. You need to figure out if the mutual fund objectives would cater your investment need. Time Horizon is the length of time until you need to sell your investment. It can be called Short Term, Medium & Long term.
  • Short Term: If you have short tenure, picking a debt fund is a good option. These funds invest in debt securities such as Treasury Bills, Government Securities, Bonds & Debentures where risk is very low
  • Medium Term: For Investor with medium tenure, Balance Fund which have exposure to both debt & equity are a good option. Equity oriented balance funds invest at least 65% in equity fund & rest in debt securities. Debt oriented balance fund invest 65% or more in debt fund, and balance in equity to offer a yield – kicker to debt investor.
  • Long Term : This investor can opt for more exposure to Equity .Equity fund invest primarily in equity & equity related instruments.

Size of the Fund (Asset Under Management) : A large fund has some obvious cost benefits. The most important benefit pass to investor when the fund size grows reduction expense ratio in the fund. A large AUM will allow skillful fund manager to exhibits his expertise effectively. Overall large fund can take better advantage of opportunities.

Top 5 AUM as on 31.12.2014 (Source AMFI)

Sr No.              AMC Name Average AUM                   (In crores)
1 HDFC Mutual Fund 150467.74
2 ICICI   Prudential Mutual fund 136763.11
3 Reliance Mutual Fund 126069.04
4 Birla Sun Life Mutual Fund 107968.20
5 UTI Mutual Fund 87390.13
  1. Mutual Fund Charges & Fees: Mutual fund make their money by charging fees to investor. Its important to know the different type of charges & fees .These fees are classified as exit load & expense ratio. These fees have major say in determining the net return on investment. Mutual fund charge an exit load on investments which are redeem before a stipulated timeframe. Expense Ratio is recurring fees charge by asset management Companies like management fees, operating expenses, marketing expenses & distribution expenses are born by scheme. Lower expenses benefit you for longer term. As the funds grow in larger in size the fixed expense associated with the fund get spread over more investor ,reducing the expenses & leaving more funds for investment.
  2. Fund Manager Experience:- Many investors do not give importance to the fund manager. Fund Manager Plays vary important role in Fund’s performance. There is need to look closely at the fund manager & several of the details that are present so that there is proper picture available for the individual for their specific investments .The fund manager with the help of his team looks at current situation of the economy, analyzes the securities that can be benefit from the current state of economy and invest in securities that conform to the funds objectives .You must judge fund manager based on the time period the fund manager has spent with the fund house ,Co fund managers role , performance of the scheme & his past record .The fund manager with tenure of 3 to 5 years or more is consider ideal for the purpose of selecting fund.
  3. Risk & Return associated with investment:-Risk & Return are an integral part of investment. It is computed by comparing the return of fund after adjusting for the risk assumed. A good mutual fund is one who gives better return than others for the same kind of risk taken. Popular methods of measuring Risk adjusted returns are Sharpe Ratio, Treynor Ratio. Also check Standard Deviation, Alpha & Beta of the fund
  • Sharpe Ratio :-Sharpe Ration is a simple one number representation .It indicates return per unit of risk. Therefore higher the ratio, better the fund.
  • Treynor Ratio:- It is very similar to Sharpe Ratio. It indicates excess return over the risk free rate to additional risk taken .Higher the ratio better the performance of the fund.
  • Standard Deviation:-It measures volatility of the returns from mutual fund scheme over a particular period .Higher the standard deviation of returns higher the risk. Hence while comparing the performance of the two funds ,you should opted for the one with lower standard deviation ,which would indicate the fund will not experience extreme highs & lows and its value will continue to grow gradually.
  • Alpha:-It tells us what extra or less the fund manager has generated out of given portfolio in comparison to benchmark. In other words it is the performance ranking of the fund manager.
  • Beta:- It tells you how much a fund’s performance would swing compared to benchmark. It is typically measured by assuming that the market portfolio, as represented by an index, will have a beta of 1.Stocks with a beta lower than 1 is tend to be less volatile than the index & vice-verse.
  • R-Squared:- It is the statistical measure which indicates how is the movement of the fund in the line with the index. High R-Squared means it is highly matching with the Index performance which it is following.

The above mentioned few points are basic things you need to check before investing. You can get all this information related to scheme on the website of the fund. Also find these details, comparison on the website of mutual fund tracker such as Value Research, Money Control, Indian Mutual Fund, etc.

Disclaimer:- The opinion expressed in article are personal opinion of author. This platform is used to spread the knowledge about Personal Financial Planning.

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