Tips to find a perfect Mutual Fund
To reduce the overall risk of the investments, people generally follow the strategy to diversify their investments. The options for diversifying the strategies are Mutual funds, FDs, Insurance policies, PPF, stocks, etc.
In recent times, one of the popular investment options for retail investors is Mutual funds. But people generally take advice from the agents or invest in the mutual funds without developing any understanding of them. People think that it is difficult to understand the mutual funds but this is not true if you properly learn how to analyze the mutual funds. This article will provide some tips to understand and analyze the mutual funds and will help in selecting the best mutual fund as per the requirement.
1. Find out the Fund performance with respect to the benchmark performance
The most important thing for analyzing a mutual fund is finding out the performance of the fund against the performance of the benchmarks. Every mutual fund follows a benchmark against which it measures and tracks its performance. Generally, a good mutual fund in long term beats the benchmarks consistently. The number of higher returns generated by the fund as compared to its benchmark is called the “alpha” of the fund. The higher the value of alpha, the better is the fund in terms of returns. So, the first criterion in selecting the best mutual fund is that the fund should consistently outperform its benchmark index.
2. Look at the Expense Ratio
The fee which is charged by the fund house for managing the overall portfolio is called the expense ratio. This fee includes the fees of the fund manager, investor transaction, distribution, and other charges. The expense ratio is proportional to the returns of the fund. Higher expense ratio results in the lower side of the returns of the portfolio. The second criterion to analyze the mutual fund is the expense ratio of the fund should be in line with its competitive funds.
3. The risk associated with the mutual fund
In all the mutual fund advertisements we have heard that mutual funds are subject to market risks and it is one of the most important statements to consider before investing. Therefore, it is advised that investors should match their risk tolerance with the risk profile of the fund. SEBI (Security Exchange Board of India) has made it mandatory for mutual funds to disclose their risk profile to investors. This can be analyzed through a riskometer through 5 categories i.e., low, moderately low, moderate, moderately high, and high. If your risk appetite is low then you should stay away from high-risk mutual funds like mid-cap and small-cap.
4. Portfolio turnover ratio
The portfolio turnover ratio is the frequency of buying and selling securities by the fund manager. It is directly linked with the fund management fees i.e., the higher the portfolio turnover ratio, the higher the fund management fees. Often, for increasing the management fees, fund managers indulge themselves in excessive portfolio churning. Continuous monitoring of the portfolio is important but at the same time, it should be ensured that churning of the portfolio results in superior returns. Therefore, keeping track of the portfolio turnover ratio is important to analyze the mutual fund.
5. (MosDEX) The margin of safety index
The margin of safety index is a measure that indicates the cost of equity schemes i.e., are they cheap or expensive. The scheme is undervalued if the value of MosDEX is high whereas, the scheme is overvalued or expensive if the value of MosDEX is low. So only knowing the right fund for the investment is not enough, you should also know the right time and right price to invest in that particular mutual fund scheme.
6. Examine the Alpha and Beta of the fund
The alpha ratio of a fund is important in knowing the worthiness of an asset or fund for investing. Alpha measures the extra returns generated by the fund compared to its benchmark while beta measures the risk involved in that fund.
If the value of beta is greater than 1, the gain or loss of the fund is more than its benchmark and if the value of beta is less than 1, the gain or loss in the fund is less than its benchmark. If two firms have the same beta i.e., their level of risk is the same, then the fund whose alpha is higher can generate higher returns compared to the other fund.
7. Fund Indicator strength
A strength indicator is a measure used to analyze the strength of the fund. It suggests the resiliency of a fund in a volatile market and the ability of the fund to generate higher returns at lower risk levels with the help of ratios like alpha, beta, Sharpe ratio, standard deviation, etc. Here, the standard deviation of the fund measures the fund’s volatility. If the fund’s returns are more volatile then its standard deviation will be higher. Sharpe ratio is the measure of additional return generated by the fund per unit of risk taken. A higher Sharpe ratio suggests that the fund is better in giving the risk-adjusted returns.
8. Quality of Mutual fund schemes
A mutual fund is a combination of different securities to develop a single scheme. It is the type of fund which determines the total number of holdings in a particular scheme. Generally, index funds are expected to have a large number of holdings (in hundreds of stocks). Therefore, it is important to analyze the quality of holding that the fund is having.