Choosing a mutual fund scheme

28 August, 2007:

Choosing a mutual fund scheme is a tough task today than ever. With over 30 fund houses to pick from, and most of them claiming first-rate performance, investors are finding it extremely difficult to select a scheme. For example, if one has to look at the performance of most of the equity funds in the last year, most of them have returned 100% or more. How can one find fault with any of them. The case is not very different in the debt segment, too. Only a percentage point differentiates the top performers. Indeed, how can one pick the right fund house?

“It is all about their business practice,” says the head of a private sector mutual fund. “The most important aspect is how they conduct themselves. How transparent they are in their operations.” He cites the example of Templeton mutual fund, which advertised the departure of their fixed income head and the succession of his understudy in various newspapers. “They have no statutory obligation to do so. Still they chose to do it own their own to reassure their investors,” he says.

That is exactly what financial advisors want you to do. Take your eyes off the percentage of returns and gauge the reputation and service standards of the fund house. “A few percentage difference in return alone shouldn’t be used as yardstick to select a fund. If the fund house doesn’t have high ethical standards, the best performance can turn into a nightmare in no time,” says a financial consultant. He cites the example of a few funds, which came under the lens of the market watchdog recently for various improprieties.

This is not to say that performance does not count. Indeed, your objective is to enhance returns on your investment. However, you should not overlook what yielded that performance. For example, a fund can take huge risk and book exceptional profits. However, if the strategy backfires, you will incur heavy losses. Sure, if you knew you were taking huge risk for high rewards, it is a fair game. However, if you are caught unaware by the sudden change of tactics of the fund, then it sure hurts. That is why you should always look at the portfolio of a scheme before investing in it.

“You will get a clear picture of the investment style of a fund if you look at the portfolio of the scheme,” says the financial consultant. For example, assume that you are evaluating the performance of diversified funds. Among the top performers, the portfolio will reveal that one scheme has only top quality stocks, whereas the other has a large exposure to mid-cap companies. In a rising market, the scheme with large mid-cap may outperform the other, but when the market is in a bad shape mid-cap can also take severe beating. So, make sure that your objective matches with the fund’s strategy.

Now, you can turn your attention to returns. Do not limit your reading to three-month or one-year return. Go further and find out how the fund has performed historically. Taking a longer-term perspective will tell you whether the fund has performed evenly in bad weather, too. For example, all equity funds performed exceptionally well last year. However, the stock market boom largely aided that. If you go little further behind, you will find out some of funds were abysmal performers in the lackluster market.

“All boats rise with the sea. But you should also remember the opposite is also true,” says the CIO of a private sector mutual fund. “Even historical returns get altered because of an exceptional year. So, it is very important to compare returns over a longer period.” According to him, you should compare the performance of the scheme since inception, not just with relevant benchmarks, but also with its competitors. It is crucial because most funds provide performance against benchmarks, but you would not get the clear picture unless you compare the performance with its peers.





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