“Hi Siddharth, so good to see you”, said Akash.
Siddharth is an Advertising Producer who owns a production firm. Siddharth and Akash, college buddies, met after a couple of years last night. During dinner, the discussion led to their personal finances.
“How’s your production firm doing? I assume in 5 years it’s reached heights you’ve always wished for”.
“Yes, Akash it’s doing well, but what I am unable to achieve is my personal financial goals. Somehow, my savings don’t seem to be enough to buy a house in town”.
“Where do you park your money every month?”, asked Akash.
“FD! I transfer all my savings into bank fixed deposits. That the best I know”.
“You mean, all your annual savings just into one investment avenue! Why don’t you invest into Equity, Equity mutual funds, or other asset classes?”
“Come on Akash, don’t you remember my love-hate relationship with Math? I still do not understand math basics. And so, I do not invest in the markets. Calculating Alpha-Beta is beyond my reach. Further, it would be too much of a risk, I believe”.
“That’s a gross misconception. You need not be good at math to be a successful investor. You only need to have a practical and pragmatic approach toward investing”.
Like Siddharth, do you have the fear of numbers and stay away from the idea of investing?
Well, you only need to understand are some basic concepts of mutual funds.
Read on this piece to learn about what you need to know to become a successful mutual fund investor.
- Fund Manager and his team
Mutual funds issue units to the investors in accordance with the quantum of money they have invested.
The combined securities and assets the mutual fund house owns is known as its portfolio. This is managed by a qualified investment professional, the Fund Manager.
The fund manager is supported by the Investment or Research Team, who are qualified professionals keeping track of the market. They look out for opportunities available in the market and make investment decisions accordingly.
Remember, fund managers are experienced money managers and their mandate is to outperform the benchmark index of the fund. And, if these experienced managers have chosen the diversification route that tells us a little about how to go about making money in the stock markets.
Hence, it is a professional team who manages your money and you aren’t dabbling in any mathematical calculations.
- Net Asset Value
Each unit an investor holds represents a portion of the portfolio. The value of the units held fluctuates with respect to the underlying value of it. This value of each unit is represented by the Net Asset Value (NAV) of the fund.
All the AMCs disclose the daily NAV by 9 pm on all business days. You can check for daily NAVs on most of the major mutual funds research companies and on AMFI portal.
Again, you do not have to calculate the Net Asset Value, it’s the AMC who does the job for you. Remember, increase or decrease in the NAV of a mutual fund scheme is a function of how well the fund manager makes his investments bets in the market, as well as how long the fund has been in the industry.
- Understanding Risk vs. Return
Now, like Siddharth, are you worried about those Alpha and Beta calculations?
Technically, there are number of risks such as market risks, price risk, default risk, interest risks, amongst others that your fund manager encounters while building a portfolio.
And, as an investor, you can assess the risk exposure that he/she’s been taking and that may be tagged even going forward. There are various measures used to calculate risks. Let us introduce and acquaint you with few of them...
Risk: Standard Deviation
Risk is normally measured by Standard Deviation (SD). It signifies the degree of risk the investors of a fund house are exposed to. From an investor’s perspective, it is important to evaluate the risk parameter of a fund because it limits the impact of market volatility on capital in tandem with time horizon. So, the fund manager assesses whether or not the fund’s risk profile matches the investor’s. For example, if two funds have delivered similar returns, then a prudent investor will invest in the fund which has been exposed to lower risks, i.e. the fund that has a lower SD.
Risk-adjusted return: Sharpe Ratio
This is normally measured by Sharpe Ratio (SR). It signifies how much return a fund has delivered vis-à-vis the risk taken. Higher the Sharpe Ratio, better the fund’s performance. As investors, it is important to know this because they should choose a fund which has delivered higher risk-adjusted returns. In fact, this ratio tells us whether the high returns of a fund are attributed to good investment decisions, or to higher risk.
What is the alpha of a fund?
The excess return generated by the fund over and above the benchmark index is called as Alpha. It is represented as a single number how the fund has performed as compared to its benchmark.
Please note that these risk return parameters of a fund are declared on monthly basis by the fund house in their Factsheet. You can again check these number on various mutual fund research websites.
Since all the calculations are done by the experienced individuals, your job is to understand those concepts well.
Star Fund Ratings/ Rankings
Often, investors make their investment decisions based on the fund's ranking or the number of stars allotted to it. Fund rankings and ratings have gained popularity over the years; a higher ranking/rating is construed as a sign of the fund being a good investment avenue.
Sadly, what investors fail to realise is that often rankings/ratings are based only on the past performance on the net asset value (NAV) appreciation front. Very few rankings/ratings in the market consider factors such as volatility and risk-adjusted performance. So, the fund's NAV might have grown over the years, but with a very high-risk factor.
At best, rankings and ratings can serve as starting points for identifying a broader set of "investment-worthy" funds. But investing in a fund based solely on its ranking/rating would be inappropriate.
However, more important are the qualitative factors of funds such as investment philosophy, fund objective, etc.
Investment philosophy, processes and systems
After having done an evaluation on the fund manager and risk return parameters, what is the broader investment philosophy of the fund house. Moreover, you also need to assess whether investment processes and systems have been well laid down by the respective mutual fund house. Prudent investment processes and systems have a major impact on mutual fund schemes performance.
This helps them sail well during the turbulence of the equity markets and also when the fund manager quits or retires from his job. This is because everything is well-defined through an investment process and system (along with a mandate which a respective fund follows), and is not left to the fund manager’s whims and fancies.
Investment objective
Every mutual fund scheme, whether equity or debt has an investment objective. As investors, ensure that your investment objective of the mutual fund scheme suits your objective of investing as well.
For example, if you have an objective of capital appreciation with a long-term investment horizon in mind and are willing to take high risk, then you should be looking at equity oriented mutual funds.
Wish to know how to select a winning mutual fund scheme, download our free guide: 10 Steps to Select Winning Mutual Funds.
In this issue you will learn:
- Why is it necessary to hold winning mutual funds
- How to compare performance of mutual funds
- What to look for in a fund’s portfolio
- Steps to build a solid mutual fund portfolio; and more
To Conclude…
Investing in mutual funds is not a rocket science nor do you need to be a genius at math. All you need to do is understand the basic terms of mutual funds so that you can make informed decisions. It is about understanding simplified concepts. And making an informed decision.
Among the factors listed above, while few can be easily gauged by investors, there are others that information remains unavailable in the public domain. This makes analysis of a fund difficult for investors and this is where the importance of a prudent and unbiased mutual fund advisor comes into play. At Personal FN, we dedicate time and effort to short-list the best funds for investors by using various qualitative and quantitative techniques.
Happy Investing!
Also watch our video on How to Select Mutual Funds
You may also like to read:
10 points you must know while investing in Mutual Funds
Mutual Fund investing myths debunked!!
10 Basics First-time Mutual Fund Investors Need To Know
It is vital to select winning MF schemes prudently
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