5 parameters of selecting best mutual fund scheme !!!

At the onset let me clarify that best mutual fund scheme does not mean the best in returns, but the one best suited to your risk profile and goals and the one that is good in its peer group. The biggest mistake that mutual fund investors make is selecting mutual funds only on the basis of performance and that too just the recent performance.

There are some investors who consider only the star ratings given by various research agencies. These star ratings can be one of the factors to look at, but there are many other parameters that one should look into before finalising a mutual fund portfolio.

The aim of this article is to apprise you with some of those parameters.

1. Performance Ranking

More than the recent or long term performance of any scheme its ranking among peers should be looked at. To find out the ranking you need to check out the quartile ranking which will show how the fund has performed quarter on quarter among its peer group. In quartile ranking each quartile comprises of 25 percent of peer group schemes.

So one may select the scheme which has remained in top quartile most of the time. If at all you find your scheme going below 3rd quartile in a couple of consecutive quarters it hints that time has come to exit the scheme. You can find these rankings from the factsheets of various AMCs and also on some mutual funds research websites.

2. Ratio analysis

Risk and return ratios like standard deviation, Sharpe ratio etc. I have discussed in my earlier article on Measuring Mutual funds risk. Along with those ratios, one also should check out the ALPHA of the fund.  Alpha tells us what extra or less the fund manager has generated out of a given portfolio in comparison to benchmark.

In other words alpha is the performance ranking of the fund manager. You may check how often the fund manager has generated positive alpha in last few quarters and also keep a watch on its consistency going forward.

3. Total expense ratio

Expense ratio is very important parameter to be looked at while selecting any mutual fund scheme. All fund management and distribution related expenses are borne by the scheme. This means high expense ratio will affect the fund’s returns.

Though mutual fund’s total expense ratio has been capped by SEBI, still lower the better unless we get some extraordinary return by paying higher expenses for fund management.

4. Fund manager tenure and experience

Fund manager plays a very important role in the fund’s performance. Though it is a process oriented approach but still fund manager is the ultimate decision maker and his experience and view point counts a lot. You should know who is the fund manager of the scheme and what is his past track record.

You should also look at the performance of other funds which he is managing. If the fund manager of the scheme has recently been changed, don’t panic.  Just keep a watch on his performance by looking at alpha and quarter to quarter performance.

If you find that due to change in the fund manager there is considerable effect on the fund’s performance which does not suit your risk appetite then you may make a decision to exit.

5. Scheme asset size

This parameter is different for debt and equity schemes. In equity the comfortable asset size in hundreds of crores, in debt it should be in thousands of crores as the investment value per investor is higher in debt funds. 90 percent of total assets under management (AUM) of the mutual fund industry are invested in debt funds, so your selected scheme assets should also have a considerable AUM.

Less AUM in any scheme is very risky as you don’t know who the investors are and what quantum of investments they have in this particular scheme.

Exit of any big investor out of any mutual fund may impact its overall performance very badly and the remaining investors in a scheme will have to bear the impact.  In schemes with larger AUMs this risk gets minimised.   

You must have observed that all the above mentioned parameters are overlapping each other in some way or the other. A good fund manager will automatically result in better performance and thus improve the quartile ranking and would also generate good alpha.

High scheme assets will help in reducing the total expense ratio of the scheme.  But, as the popular saying goes- ‘There is no scientific way to choose tomorrow’s best funds today’, so one should review the current selection every quarter or half yearly.

7 common types of mutual funds

1. Money market funds

These funds invest in short-term fixed income securities such as government bonds, treasury bills, bankers’ acceptances, commercial paper and certificates of deposit. They are generally a safer investment, but with a lower potential return then other types of mutual funds. Canadian money market funds try to keep their net asset value (NAV) stable at $10 per security.

2. Fixed income funds

These funds buy investments that pay a fixed rate of return like government bonds, investment-grade corporate bonds and high-yield corporate bonds. They aim to have money coming into the fund on a regular basis, mostly through interest that the fund earns. High-yield corporate bond funds are generally riskier than funds that hold government and investment-grade bonds.

3. Equity funds

These funds invest in stocks. These funds aim to grow faster than money market or fixed income funds, so there is usually a higher risk that you could lose money. You can choose from different types of equity funds including those that specialize in growth stocks (which don’t usually pay dividends), income funds (which hold stocks that pay large dividends), value stocks, large-cap stocks, mid-cap stocks, small-cap stocks, or combinations of these.

4. Balanced funds

These funds invest in a mix of equities and fixed income securities. They try to balance the aim of achieving higher returns against the risk of losing money. Most of these funds follow a formula to split money among the different types of investments. They tend to have more risk than fixed income funds, but less risk than pure equity funds. Aggressive funds hold more equities and fewer bonds, while conservative funds hold fewer equities relative to bonds.

5. Index funds

These funds aim to track the performance of a specific index such as the S&P/TSX Composite Index. The value of the mutual fund will go up or down as the index goes up or down. Index funds typically have lower costs than actively managed mutual funds because the portfolio manager doesn’t have to do as much research or make as many investment decisions.

ACTIVE VS PASSIVE MANAGEMENT

Active management means that the portfolio manager buys and sells investments, attempting to outperform the return of the overall market or another identified benchmark. Passive management involves buying a portfolio of securities designed to track the performance of a benchmark index. The fund’s holdings are only adjusted if there is an adjustment in the components of the index.

6. Specialty funds

These funds focus on specialized mandates such as real estate, commodities or socially responsible investing. For example, a socially responsible fund may invest in companies that support environmental stewardship, human rights and diversity, and may avoid companies involved in alcohol, tobacco, gambling, weapons and the military.

7. Fund-of-funds

These funds invest in other funds. Similar to balanced funds, they try to make asset allocation and diversification easier for the investor. The MER for fund-of-funds tend to be higher than stand-alone mutual funds.

Before you invest, understand the fund’s investment goals and make sure you are comfortable with the level of risk. Even if two funds are of the same type, their risk and return characteristics may not be identical. Learn more about how mutual funds work. You may also want to speak with a financial advisor to help you decide which types of funds best meet your needs.

Diversify by investment style

Portfolio managers may have different investment philosophies or use different styles of investing to meet the investment objectives of a fund. Choosing funds with different investment styles allows you to diversify beyond the type of investment. It can be another way to reduce investment risk.

4 common approaches to investing

1.            Top-down approach – looks at the big economic picture, and then finds industries or countries that look like they are going to do well. Then invest in specific companies within the chosen industry or country.

2.            Bottom-up approach – focuses on selecting specific companies that are doing well, no matter what the prospects are for their industry or the economy.

3.            A combination of top-down and bottom-up approaches – A portfolio manager managing a global portfolio can decide which countries to favour based on a top-down analysis but build the portfolio of stocks within each country based on a bottom-up analysis.

4.            Technical analysis – attempts to forecast the direction of investment prices by studying past market data.

India's best mutual fund managers

Here is a list of the best asset managers in the fund industry taking their 5-year risk adjusted performance into account.

ET Wealth teamed up with Morningstar India to bring you its comprehensive annual study of the best equity fund managers based on their 5-year performance.

• The study was restricted to open ended, actively managed, diversified equity funds.
• Only funds with a corpus of at least Rs 200 crore were considered.
• The performance period was July 1, 2012 to June 30, 2017.
• For a fund to qualify, the fund manager needed a minimum 2-year track record with that fund as a lead manager. While identifying the lead fund manager of each scheme, only the primary fund manager mentioned in the scheme's fact sheet was considered.
• The study was restricted to fund managers cumulatively managing an AUM of at least Rs 500 crore, across all qualifying funds.
• After short-listing the fund managers, the aggregate returns generated by each fund manager were calculated over the 5-year period for all the funds managed by him which satisfied the qualifying criteria. The returns were then adjusted for risk.

Neelesh Surana AMC: Mirae Asset Global Investments 5-year asset weighted return: 26% Average 5-year AUM: Rs 2,282 cr Funds: Mirae Asset Emerging Bluechip, Mirae Asset India Opportunities, Mirae Asset Tax Saver

R Janakiraman AMC: Franklin Templeton Mutual Fund 5-year asset weighted return: 25.98% Average 5-year AUM: Rs 7,333 cr Funds: Franklin India Opportunities, Franklin India Prima, Franklin India Smaller Companies

Sohini Andani AMC: SBI Mutual Fund 5-year asset weighted return: 22.61% Average 5-YEAR AUM: Rs 4,824 cr Funds: SBI Banking and Financial Services, SBI Bluechip, SBI Magnum Midcap

Chirag Setalvad AMC: HDFC Mutual Fund 5-year asset weighted return: 24.69% Average 5-year AUM: Rs 10,420 cr Funds: HDFC LT Advantage, HDFC Mid-Cap Opportunities, HDFC Small Cap

Vinit Sambre AMC: DSP BlackRock Mutual Fund 5-year asset weighted return: 28.51% Average 5-year AUM: Rs 3,655 cr Funds: DSP BlackRock Micro Cap, DSP BlackRock Small and Midcap

Roshi Jain AMC: Franklin Templeton Mutual Fund 5-year asset weighted return: 24.66% Average 5-year AUM: Rs 2,464 cr Funds: Franklin India High Growth Companies

Ajay Garg AMC: Aditya Birla Sun Life Mutual Fund 5-year asset weighted return: 22.03% Average 5-year AUM: Rs 2,155 cr Funds: Aditya BSL MNC, Aditya BSL Tax, Aditya BSL Tax Relief 96, Aditya BSL Tax Saving

Krishnakumar AMC: Sundaram Mutual Fund 5-year asset weighted return: 25.57% Average 5-year AUM: Rs 5,075 cr Funds: Sundaram Diversified Equity, Sundaram Infrastructure Advantage, Sundaram Rural India, Sundaram Select Mid Cap, Sundaram SMILE

 Pankaj Tibrewal AMC: Kotak Mutual Fund 5-year asset weighted return: 24.89% Average 5-year AUM: Rs 910 cr Funds: Kotak Emerging Equity, Kotak Midcap

 Mrinal Singh AMC: ICICI Prudential Mutual Fund 5-year asset weighted return: 22.38% Average 5-year AUM: Rs 8,877 cr Funds: ICICI Prudential Dividend Yield Equity, ICICI Prudential Midcap, ICICI Prudential Select Large Cap, ICICI Prudential Value Discovery

Link : https://www.advisorkhoj.com 

Link : Top Rated MF !!!

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Ratios worth considering while selecting Equity mutual fund

Mostly selection of mutual fund schemes are done based on their past performance, corpus, expense ratio, sector exposure, etc. Out of these, past performance criteria is widely used among investors. Though past performance of the fund is important but it completely ignores the risk taken by the fund manager to generate returns.

Funds in the same category can have similar returns but varied risk profile. So, portfolio which has lower risk should be preferred.

Before looking at the ratios, let us know how risk is measured for Equity mutual funds.

Broadly, Equity mutual funds are exposed to two types of risks — systematic risks (measured by Standard Deviation) & unsystematic risk (measured by Beta).

What is Standard Deviation?
 Standard Deviation is the measure of the deviation in the returns of the portfolio. In Simple Words it tells us how much scheme return can deviate from the expected normal return

What is Beta?
 Beta is a measure of fund’s volatility to that of its Benchmark index. It tells you how much a fund's performance can swing compared to its benchmark. Higher the Beta, higher will be the volatility in the returns that the fund generates compared to the index.

Sharpe Ratio

Sharpe ratio is a measure of the excess return generated by a portfolio relative to the total risk it is exposed to.

Sharpe Ratio tells us whether the returns of the scheme are due to smart investment decisions or a result of excess risk taken. Higher the Sharpe ratio better is the performance of the fund for taking on additional risk.

Example

Sharpe Ratio of fund A = {14% (Funds performance) – 6% (Risk free rate)} / 5% (Std Dev) = 1.6

Sharpe Ratio of fund B = {12% (Funds performance) – 6% (Risk free rate)} / 3% (Std Dev) = 2.0

Here we can see that though returns generated from fund A are better than that of fund B, the risk adjusted return of fund B is more than that of fund A.

Treynor Ratio

Treynor ratio is a measure of the excess return generated by a portfolio relative to the market risk (beta) it is exposed to.

It is a better measure of performance for equity funds as it takes into account market volatility. Higher the treynor ratio better is the performance of the fund for taking market risk.

Example

Treynor Ratio of fund A = {10% (Funds performance) – 6% (Risk free rate)} / 2.5% (Beta) = 1.60

Treynor Ratio of fund B = {11% (Funds performance) – 6% (Risk free rate)} / 3.5% (Beta) = 1.42

Here we can see that though returns generated from fund B are more than that of fund

A, the risk adjusted return of fund A is more than that of fund B.

Jensen’s Alpha

Jensen’s Alpha measures the difference between fund's risk adjusted returns with the risk adjusted return of its benchmark index, given its level of risk measured by beta.

Alpha is used to evaluate the performance of the fund manager. A positive value of alpha shows the market timing and stock picking skills of the fund manager.

Jensen’s alpha can be positive, negative, or zero. If alpha is positive the fund is outperforming the benchmark index. As fund's return and its risk both contribute to its alpha, two funds with same returns could have different alphas

There is an exception to this rule; index funds which may be perfectly correlated with its benchmark still have negative alphas because of the expenses charged by the fund.

The Sortino ratio measures the risk-adjusted return of an investment asset, portfolio, or strategy.

As standard deviation involves both the upward as well as the downward volatility.

Since investors are only concerned about the downward volatility, Sortino ratio presents a more realistic picture of the downside risk ingrained in the fund or the stock.

This ratio is a modification of the Sharpe ratio but penalizes only those returns falling below a user-specified target or required rate of return, while the Sharpe ratio penalizes both upside and downside volatility equally.

Sortino ratio: (R) - Rf /SD

where,
(R): Expected return

Rf: Risk free rate of return

SD: Standard deviation of the Negative Asset Return.

This ration should not be looked at into isolation and should be looked at with other risk parameters and is useful while analyzing volatile funds as there is more possibility of downside deviation.

Kindly Note : All ideas and materials presented herein are for informational and educational purposes only, and is not intended for commercial or trading purposes. Neither does it mean to misguide anyone. Kindly make informed decisions on your own risk. Neither livettcelearn.blogspot.in website nor any of its owner shall be liable for any errors or delays in the content or for any actions taken in reliance thereon.