How to judge the performance of your mutual fund investment

29 August, 2007:

Are you thinking of investing in a mutual fund scheme, but do not know how to assess the performance of a fund? Already invested in a scheme, but you don’t know what to make of that performance record the fund has sent you? Do not worry. It is easier than you think. Just follow this three-step formula and you would be fine.

One, you should find out how the scheme has performed. You do not have to take your calculator out. Most funds give their performance for one month, three month, six month, one year, and three years and since inception. The performance will be given in simple percentage points. If you want something more refined, visit various websites or go through various publications, which might use analysis that is more rigorous. Most commonly used method is risk-adjusted returns. According to many financial advisors, this gives a better picture of the scheme. The logic is that the risks should be rewarded with better returns.

Two, find out how the fund fared in comparison with its peers? This is easy, as all you have to do is to repeat the similar exercise with the other funds, too. Look up for the performance of other funds. You can use the same sources for this examination. However, a word of caution: You should find out whether the returns are calculated in the same method. Also, it is important to find out whether the objective and characteristics of the schemes match each other.

It goes without saying that if a fund constantly lags behind its competitors, there is something wrong in its investment strategy. However, you should pay great attention to the investment approach of the fund before making the decision to quit it. For example, a conservative investment approach may mean lagging behind peers in times of boom. However, when the market falls, the conservative fund may score over others.

Lastly, find out the performance of the fund vis-à-vis the market benchmark. For example, a diversified equity fund should be on par or above the broad index of Bombay Stock Exchange or National Stock Exchange. Similarly, you should check out relevant index if you are investing in sectors. For example, you should check the IT index if you have investments in a Technological fund or pharma sector index if you are an investor in a pharma
fund.

Now, why do we do this? The idea behind investing in a specialized fund, be in diversified or sectoral fund, is to outperform the market benchmark. In fact, that is why you are paying the fund manager a fee. If he is not able to beat the benchmark, there is something wanting in his investment skills. In short, he is not worth the money you are paying. You would have been better off in an index fund, where the costs are lower. Also, there is no risk of a great downslide.

This is because an index fund invests only in stocks in proportion to their weightage in the index. It is a passive investment strategy. The returns would be in tandem with the movement of index, save for a small tracking error. Since these funds do not have to churn their portfolio heavily, the transaction costs are also lower. In addition, you do not have worry about the performance record of the fund manager, as investing in an index is not rocket science. He do not have to go for great stock picks, all he has to do is to keep a portfolio as close to the index.