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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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