You know mutual funds can give you impressive returns on your investment. But how do you select the best performing mutual fund? To be very frank, this is a complex question that requires a deeper understanding. For a beginner, it might be difficult to grasp the terms and technicalities. But once you are aware of these aspects, you will be able to invest wisely.
Before we discuss the procedure for selecting the best performing mutual fund, we would mention the factors that influence an investor’s decision. These are:
- Identification of Goals–If you desire to buy a car or fund a foreign vacation, you need a small corpus. If you desire to purchase a house or fund child’s education, you need a large corpus.
- Investment Tenure – Based on your goals, the investment tenure can be categorized into short term and long term. Greater the tenure, greater will be the returns.
- Risk Tolerance– If you have an appetite for risks, you can garner massive gains on your investment. However, there are mutual funds with varying risk exposure, thereby, suitable for every investor.
Based on your preferences listed above, you compare mutual fundsas per your requirement. While analyzing, emphasize on the following aspects.
Total Expense Ratio
According to SEBI, the expense ratio for equity-oriented schemes will be maximum 2.5% and for the debt funds, it will be 2.25%. The total expenses comprise of fund management, communication services, and so on. Lower expense ratio means greater profits. Consider expense ratio while analyzing mutual funds. If the returns are high, the expense ratio won’t make much difference but if the returns are moderate, total expenses might wipe out a considerable portion of profits.
When you invest in risk-free instruments such as government securities and bank deposits, you are guaranteed returns at a particular rate of interest. When you compare a mutual fund return against the risk-free instrument, you get the risk-adjusted returns. Thus, if the value of risk-adjusted returns is higher, the mutual fund is generating high returns. Sharpe Ratio is an indicator of risk-adjusted return. It is the ratio of excess return of a fund over a risk-free instrument to the Standard Deviation (measures volatility of a mutual fund).
Assets under Management (AUM)
The amount of money invested in a mutual fund scheme denotes the total assets under management (AUM). The schemes that have high AUM, they are bound to perform better because they have the corpus to invest strategically. Those schemes that have low AUM, their performance is always dicey. You should select schemes whose AUMs are greater than the average AUM in the category.
Here we will introduce a new term, quartile ranking. The rankings of mutual funds are evaluated on a quarterly basis. The funds are categorized in a batch comprising 25% of the total mutual fund schemes. Thus, we have four batches – 0-25%, 26-50%, 51-75%, and 76%-100%. A mutual fund scheme will be awarded a quartile ranking of 1 in the first batch, 2nd in the second batch, and so on. If you have invested in a mutual fund scheme that is achieving 3rd quartile ranking for a couple of quarters, you should consider exiting the scheme.
Fund Manager Authority
The total experience and the past track record depict the authority of the fund manager. Do a background inspection before investing your money. The Alpha value can be used to predict the ability of the fund manager. Alpha value denotes the excess returns obtained compared to the benchmark index. In addition to this, keep a close vigil on the quarter wise performance as well.