If you have decided to include the mutual fund in your investment strategy and don’t know how to select the best mutual fund from that category, here are the quick 7 points that you need to consider.
1. The investment objective of the fund
Before investing in a particular fund we need to understand the objective of the fund. It is very important to have a clear understanding of the investment objective and its fitment in one’s portfolio. The investment objective explains the rationale behind the investments.
Focused fund: To generate long term capital appreciation by investing in a concentrated portfolio of equity & equity related instruments of up to 25 companies.
Smallcap fund: To generate long-term capital appreciation from a diversified portfolio of predominantly equity & equity related instruments of smallcap companies.
The above examples of investment objectives clearly explain the purpose of the fund and the type of avenues where the investments are made.
2. Track record and competency of the fund manager
The equity market is a tough terrain to stay with. The people who don’t understand it ends up losing money. It’s obviously not everyone’s cup of tea. It needs a lot of experience and knowledge to take timed financial decisions. That’s why we are giving our money to an expert, a fund manager, who manages a mutual fund. It’s our responsibility as an investor to understand the fund manager and his investment style.
Now every AMC published the data regarding the fund managers and their experience, their association with the fund, etc. You can also watch YouTube videos and interviews with these managers to understand their investment ideology. I always give preference to funds where fund managers invest their own cash. As the industry says “Skin in the game”. Many AMCs are publishing this data as well.
3. Track record of the fund
Once we know the category of the fund, it’s easy to compare it with the category benchmarks. Even though ‘Past performance is no guarantee of the future’- we always have to see how the fund performed in the last 5, 10 years. The long term picture shows how the ideology of the fund manager worked in the past. Funds that have a bigger deviation from the category average or benchmark should be always avoided.
4. The expense ratio of Mutual Funds
The expense ratio tells you the fees that you need to pay towards the fund house for managing the fund. It is important to understand the expense ratio of the fund as it will create an impact on net profitability.
The expense ratio is calculated by dividing the total value of the asset by the total amount of fund fees- both management fees and operating fees. We always prefer to choose a fund with a significantly lower expense ratio. You can read about the expense ratios in detail in our coming articles.
5. Quality of the assets in the portfolio
Those who like to do a little more detailed analysis before starting a fund can deep dive into the portfolio of the fund. Funds choose the underlying assets based on the investment objectives. In an equity fund, it is important to understand the quality of the stocks it holds. Since most of the information is available at our fingertips, a little online research will help us to find out more details about the companies and their past performances.
6. Churn Rate
The churn rate or the mutual fund’s portfolio turnover ratio indicates the percentage of the mutual fund’s portfolio holdings that have changed over a time period. In other words how often fund is churning the portfolio holdings.
A mutual fund with a lower churn rate means, the fund follows a buy and hold strategy and the fund manager has a high conviction on his picks. A high turnover ratio means you need to pay higher costs for the constant trading done by the fund manager. This might in effect results in lower returns.
7. Exit load of Mutual Funds
The exit load refers to the fee or charge, imposed by an asset management company (AMC) over the investor at the time of exit or redemption of the fund units. You need to note that exits loads re not the part of expense ratios that were discussed above. The exit load is normally a parentage of the net asset value (NAV). A fund with a high exit load can reduce your returns significantly.
For instance, if the exit load of a two-year scheme is 2% and you are exiting after 1 year, you need to pay a fee of 2% of your NAV, since you are exiting before the agreed investment period.
Investing is never an easy job even though it’s simple. Always understand the risk before investing. You need to put a lot of effort into setting up a portfolio that can create wealth. We will be publishing more articles about mutual funds and investment strategies in the coming editions. Always consult your financial advisor before making investment decisions.
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