Mutual Funds are the one magic investment theme that everyone has been excited about these days, but the issue is about choosing the best one, the parameters to decide and how to invest. Well, one certainly don’t want to trust some tips or some paid advices from business channels, the best option is do a little research, or hire qualified investment adviser to manage your funds. It is a complicated task to evaluate mutual funds on all of the parameters out there in financial research domain, so to make this task easy and investor friendly I have compiled a list of few parameters to analyze while considering investing in mutual funds.
Mutual Fund is collective investment scheme that pools money from investors and invests on their behalf as per their policy and restrictions. Mutual Funds are generally categorized as Open Ended and Closed Ended, but as the listing of mutual funds is allowed at the exchanges, the time frame factor of investment in these funds has almost lost its taste and value for a general investor.
This article has a list of few simple parameters to consider while investing in mutual funds for general investors, and majorly these parameters can be accessed freely from fund fact sheets and freely available analysis websites (moneycontrol.com, Morningstar.com and many more). Generally investor compares the fund’s performance with benchmarks, but selection of appropriate benchmark should also be a major deciding factor for investors.
Other important parameters are:
- CRISIL Rating: Mutual funds available in India are mandated by SEBI to attain CRISIL rating on the basis of risk; this ranking must be the first criteria to narrow down the fund selection choices. The color coding on the basis of risk level has led to differentiation of mutual fund scheme among investors and led to a fruitful decision making for them.
TIP: BSE and S&P’s Joint Strategic Venture BSE’s STAR MF SMART INVESTING platform has revolutionized the availability of database related to financial ratios and related data-points so that investors can decide-analyze these data-points and make their own informed investment decisions. Morningstar.in also provides many important performance data-points, various investment rations and other comparative parameters to analyze while investing for free on BSE’s platform.
Other important factors to consider while investing in mutual funds are:
- Morningstar Rating: Morningstar tool analyzes the mutual funds and rates them from 1 star to 5 stars based upon their performance and other parameters comparing to similar asset classes and schemes available in the markets (5 stars being the best fund in the category). Top 10% of mutual funds in a category receive 5 stars and the bottom 10% mutual funds receive 1 star. The rating is provided for 1, 3 and 5 years as well as overall star rating to check on overall performance.
- Alpha: Alpha is risk-adjusted return parameters that measure of the difference between fund’s actual returns and its expected returns, comparing the same with benchmark index. A positive alpha compared to benchmark means that the fund has performed better and a negative alpha indicates the fund’s under-performance comparing to its benchmark. So “higher the alpha, better the fund for investment purposes”.
- Beta: A volatility factor, the measure of a mutual fund’s sensitivity to market fluctuations. The market/index has its beta of 1, so a beta of 1.5 shows that the fund has performed 50% better than its benchmark index in up markets and 50% worse in down markets, assuming all remaining fund analysis factors remain constant. Beta can be a useful tool when at least some of a fund’s performance history can be explained by the market as a whole. Beta is particularly appropriate when used to measure the risk of a combined portfolio of mutual funds. So “more the Beta, better the fund’s returns but volatility also goes up with higher Beta”.
- Sharpe Ratio: Risk-adjusted performance parameter that measure the reward per unit of risk. Thus a higher Sharpe ratio compared to benchmark / category peer funds indicates better risk adjusted return for the fund, meaning less risk for higher returns. So, “higher the Sharpe ratio, better is the fund’s historical risk-adjusted performance, which may also be implicated in future considering the past performance.”
- Turnover Ratio: It checks the mutual fund’s trading activity. It analyzes the manager’s trading strategy (short term or long term) and the asset flow of the fund. So, Lower the Turnover ratio, more long term is the investment approach of the mutual fund, which shows the better stock selection and trust by the manager on investments.”
- Expense Ratio: Expense ratio is the annual fees that mutual funds charge their investors. It is expressed as the percentage of net assets. Expense ratio is inclusive of 12b-1 fees, management fees, administrative fees, operating costs, and all other asset-based costs incurred by the fund. So, “lesser the expense ratio of the fund, better are the returns of the fund”.
So, “a mutual fund must have a high CRISIL Rating, high Morningstar Rating, comparatively high Alpha, Reasonable Beta, High Sharpe Ratio, Low Turnover Ratio and Low Expense Ratio”. A Mutual Fund with such indicators can certainly be considered as one of the best available investment options in the Mutual Fund domain.