How to Evaluate a Mutual Fund Scheme’s Performance

As there are fluctuations in the markets due to the influence of the overall economic conditions, the margin of safety in markets may reduce, which may increase the scheme's risk profile above your risk appetite level. Hence, evaluating the mutual fund scheme's performance at regular intervals is crucial to take timely action in order to prevent any losses and generate better risk-adjusted returns over the long term. The majority of investors use past performance or historical data as the sole metric to assess the performance of various funds. You may have seen the caveat that a fund's previous performance does not guarantee future results. Furthermore, set realistic return expectations and don't get carried away by past returns. Although past returns are undoubtedly one of the comparison metrics, as an investor, you need to look beyond a fund's past performance.

To evaluate a mutual fund scheme's performance, you need to consider various qualitative and quantitative parameters such as:

1. Compare the performance with benchmark returns

Every mutual fund scheme is benchmarked to a particular index that helps compare the mutual fund's performance over time. It indicates the returns the fund has generated as against the benchmark, reflecting how much it should have delivered. The sole aim of an active fund manager is to beat the fund's benchmark, i.e., to generate 'alpha returns'.

For example, an equity mutual fund is benchmarked to the Nifty 50 - TRI. If the index rises by 10% whereas the NAV of the mutual fund scheme rises by 12%, then the fund is said to have outperformed the index. Conversely, if the index falls by 10%, but the fund loses by 12%, then the fund is said to have underperformed the index. Prefer mutual fund scheme that has consistently performed better than the benchmarked index, especially in falling markets. Consistency can also shed light on the skill of the fund manager. However, this is not applicable in the case of passive funds, as they tend to mirror the index performance and not outperform the index.

2. Compare the performance with category peers

A fund's performance in isolation does not indicate anything. Hence, it becomes crucial to compare the fund's performance with its category peers. If your mutual fund scheme is unable to beat its peers consistently, then the fund is not worth investing in. Always keep the performance comparison fair. It should be an apple-to-apple comparison and not apples-to-oranges, i.e., comparing large-cap funds with mid-cap or small-cap funds. Using the wrong yardstick will only give misleading information. Check if the fund has taken a higher risk as compared to its peers to deliver higher returns. The Sharpe ratio indicating the scheme's risk-adjusted returns could be helpful.

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3. Compare the returns across market cycles and time frames

When you assess returns, look at not just returns across time frames i.e. 6 months, 1 year, 2 years, 3 years, 5 years, etc.; but also if the scheme can ride through various market phases (in case of equity schemes) and interest rate cycles (in case of debt schemes). A mutual fund scheme may underperform or outperform in the short term due to shifts in the volatile market environment. However, instead of letting short-term trends influence your decisions, consider the fund's long-term performance and assess whether it is capable of consistently beating the market during several market phases and cycles. Look for a fund that has a relatively longer performance track record, say 5 to 10 years or more.

Below is the list of key financial ratios that assist in evaluating a mutual fund scheme's performance:

Apart from this, there are a few qualitative factors that you, as an investor, should take into account while evaluating a mutual fund scheme's performance.

1. Portfolio Characteristics

The portfolio's characteristics, such as the allocation in top-10 holdings, top-5 sector exposure showing how concentrated/diversified the portfolio is, the market capitalisation bias, the style of investing followed - value, growth, or blend, and the portfolio turnover. In the case of debt funds, the average maturity, modified duration, credit quality of debt papers, and expense ratio are the ones that are generally overlooked. The quality of a mutual fund's underlying portfolio, which includes the stocks and other securities it holds, has a significant impact on the success of the fund.

2. The philosophy of the fund house and credibility of the fund management team

The philosophy of the fund house helps in understanding the overall commitment of the fund house towards investors interest. Moreover, the investment systems and processes followed at the fund house and the track record the fund management team plays a crucial role in the fund's performance. The fund manager is the ultimate decision maker, and his experience and conviction count for a lot. You should also look at the performance of other funds which he is managing. If you discover that a change in the fund manager significantly impacts the fund's performance that is inconsistent with your risk tolerance, you may avoid the fund.

Check the track record and choose an efficient fund house that performs well across various mutual fund categories. Invest in mutual fund houses which follow robust investment processes and have adequate risk management systems in place. Also, analyse the overall efficiency of the mutual fund house in managing investors' hard-earned money (i.e., the proportion of AUM outperformed is an indicator of the size and success of a given fund house).

To conclude...

However, not everyone holds the expertise to analyse mutual funds in-depth using these parameters and evaluate the financial ratios required for quantitative analysis. There are various online mutual fund comparison tools available that allow you to compare two or more mutual fund schemes across varied time frames. It also provides a quick view of various details; you may receive multiple metrics in a tabular format which could include returns comparison and various portfolio attributes. Investors can conveniently use these time-saving free mutual fund screener tools that are available from a variety of FinTech companies and mutual fund research websites.

You must be aware of your investment objectives before you invest in a mutual fund scheme. Given the variety of funds available in the market, it's crucial to examine several mutual funds before investing in one of them. You must invest in a best suitable mutual fund scheme based on your risk tolerance, investment horizon, and financial goals.

PS:  If you wish to select the actively managed best mutual fund schemes, I recommend that you subscribe to PersonalFN's unbiased premium research service, FundSelect.

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Warm Regards,
Mitali Dhoke
Research Analyst