If you are new to Mutual Funds, then you may first want to read my previous blog on Mutual Funds Categories.
Chasing the best mutual funds for investing? Don’t judge mutual funds by looking at their short-term performance. There are enough examples to show that stars in short-term performance could be very mediocre or bad performers over the long term. The reverse is also true.
What do people generally look at when analyzing and researching where to invest? Most people rely on past returns to determine where to invest. This can be a huge costly mistake and should be avoided. You don’t drive a car by looking at the rear-view mirror alone. You need to be forward-looking at the windscreen when you drive the car – right? The same is also true for investing.
As per a study, returns are achieved through optimum asset allocation and not by timing the market. Asset allocation is based on the principle that uncorrelated assets perform differently in varying conditions and therefore can provide good weighted returns over a long period. Mutual funds have various asset categories as discussed previously in another blog. Investment should be goal-based and in a scheme, which is backed by research.
Ratings and ranking can be very misleading. Ranking could just be a descending order in terms of performance over the last year. Investing just based on the same could be detrimental to your goals. The fund could be cyclical (especially thematic or sector funds) or there could be risky funds like the small-cap or the mid-cap which may show a huge rally in a single year. But if you invest in those for your short-term goals, it could be a recipe for disaster. It becomes important then not to be greedy for returns, but keep the safety of the principal as the most important criterion for short-term investing.
We need to be careful with the time horizons which are being shown in advertisements or reports. Obviously, the fund would want to show their best periods where they had better return over their peers, or show the data which makes them look good. It is important to also look beyond what is obvious and that can be researched through the publicly available data like the fact sheets etc.
NFOs are regularly launched by the fund houses. Now, thanks to the SEBI Categorisation in 2018, there are clear guidelines that a fund house cannot have more than one scheme in any category other than the index funds and the sector/thematic funds. While this has certainly simplified for the investors, the fund houses would still want to get into areas that are performing well and where they may not have a presence. But, do know that buying at par at Rs 10 Net Asset Value (NAV) is not the same as buying a Rs 10 worth stock at the Initial Public Offering (IPO). Whether the NAV is Rs 100 or Rs 10, it does not matter. What is important is their relative performance within the fund’s respective category and its performance against the benchmark. Also, when an NFO is launched there is no track record and therefore could be a bigger risk. However, there can be situations where an NFO could still be considered. As an example, into a niche area where you would like to invest and there may not be other funds available. But possibilities could be very low.
Thanks to the internet, there is a lot of publicly available information on the funds. Scheme documents and factsheets (released monthly) should be reviewed regularly. It’s important to understand what we should look for in these documents.
Do not just look at the returns but also look at your risk appetite, goals and time horizons. If a
u huge volatility in any stock or a fund gives you sleepless nights, it may not be worth it. The same is also true for investments in other asset classes like real estate too. Invest what gives you peace of mind.
There are several behavioural biases that can impact investing decisions. Some of them are recency bias, loss aversion bias, availability bias etc. This is a separate topic by itself which I will cover in one of my future blogs.
Fund performance should be looked at across different cycles. When in a bullish cycle, all funds could perform well and there could be nothing special in your chosen fund. It is also important to look at that fund while it was in a bearish cycle. Good fund managers could have a strong conviction on what they purchase and may be willing to sacrifice short term returns for a much greater and better long-term performance. So, changing ships mid-way could be detrimental for the goals, more so, if there are exit loads and short-term capital gains.
As I mentioned earlier, making a decision only on past performance is not the right away as it may not be sustained in the future (remember the disclaimer). We should look at various performance ratios and compare them with other similar funds. Some of the most important ones are:
Standard deviation : It assesses the volatility of the fund. All of us would have studied this in detail in our statistics class. The Standard deviation shows how much the return of a fund can deviate from its historical mean. Lesser the standard deviation, the better is the investor experience.
Beta : It is the sensitivity of an investment return as compared to the entire market. Benchmark’s Beta is 1, anything greater than that means the investment is more volatile while less than 1 means less volatile as compared to the benchmark.
Sharpe ratio : This ratio calculated the return per unit of risk. The ratio is the average return earned over the risk-free rate, per unit of volatility. As an example, if the Sharpe ratio of a fund is 0.5, then for every unit of risk taken the fund has generated half amount of return. Higher the Sharpe ratio, better is the fund. A Sharpe ratio near 1 indicates that return is at par with the risk it is taking.
There are other ratios too, but then it is a very detailed subject to get into, which is not the scope here.
Just because investing in financial assets is transparent, it does not mean what you have to view it regularly and at times take an irrational decision that can impact the long-term performance. Short term performance in a fund may not bad. It could just be that the fund manager has long term view and conviction and is willing to hold. Or he may consider current valuation to be too high and is not willing to buy at those prices. We should understand the fund manager’s perspective, whether it is growth or value.
Patience is very important in investing and we should never let emotions dominate the investment decisions. A lot of times, not taking any decision could be the best decision which we should take.
It is important not to consider any parameter in isolation but take a holistic view when doing the research. This was an overview of investing in mutual funds. Hope you found it useful.. If lack of time, keeping busy at work, or lack of knowledge or interest in the minute details of investing are keeping you away from the best investment decisions, then it is best to avail services of a financial advisor or a financial planner. You might want to read my earlier blog on the importance of a financial planner.
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