The mutual fund universe is filled with hundreds of schemes. And this universe is expanding very rapidly. This is a good development. More schemes mean more choices for an investor. Also, the increasing competition amongst the Asset Management Companies (AMCs) has raised the fund management quality, improved the service standards and spread the investment culture.

But as the universe expands to unmanageably large size, it becomes increasingly difficult to spot the brightest of the stars. One has to patiently work through the universe using certain yardsticks and separate the brighter stars from the not-so bright ones.

Type of Fund

Today we have to live with the mid-cap funds, small cap funds, multi-cap funds, large cap funds, emerging companies funds, lifestyle funds, dividend-yield funds, PE funds and a host of sector specific funds. As a first step, therefore, identify the set of schemes, which meet your investment objectives such as the diversification, return expectation, time horizon and risk appetite. Say you are a risk taker and have 3-5 years horizon. Then a small-cap fund could meet your needs. Such companies can give spectacular returns but need time to prove their worth in the market. Or if you are a passive investor, index funds would best suit you. Having chosen the desired set matching with your needs, further yardsticks are applied to choose the specific funds.

Past Track Record

The past performance is undoubtedly the most important criterion. Has the scheme been among the top performers in the past? How does it compare with the benchmark? There is, of course, no guarantee that a fund, which has done well in past will continue with its’ good performance in future too. But, it is a reasonable assessment that a fund which has shown consistent performance over the last 3-5 years period, is most likely to perform well in the future. Therefore, it is important to assess performance over longer time frame, especially during market downturns. A 3-5 years is a good enough period to look at. A shorter time frame of 1-2 years may not be a sufficient indicator.

Quality of Returns

The fund may have been an excellent performer. But it is possible that the risk it is taking is more than what your risk appetite warrants. The ‘quality’ will determine how much risk a fund is taking to generate the returns. Equity investing is a risky business and it is important that a fund should be managing risks effectively. This is especially true now when the market has run-up quite sharply and the valuations are stretched. In the event of a sharp correction, it is the quality funds, which will usually fall less and also rise up faster when the up-turn begins .

Portfolio Characteristics

Funds come in all shapes and sizes. Some are too diversified and some too concentrated. Some are too small and some too big. A too small a fund may not be able to adequately diversify, while too large a fund may not find sufficient investment options. The corpus size needs to be commensurate with the investment space. Diversification beyond a point may prove counterproductive. Too large a portfolio may mean both dilution in returns and less efficient fund management. On the contrary, too much of concentration in few stocks would tend to increase the fund risk. Percentage holding in the top 10 stocks and the number of stocks in the portfolio will give a fair idea about level of diversification.

Expenses

One should be aware of the costs involved. Primarily, there are two expenses. One is the sales expenses i.e. the entry/exit load. This is payable at the time of buying/selling the fund. And, second is the annual fund management expense.

One should evaluate whether these expenses are in line with the industry standards of comparable funds and offer the right value for money. For example an index fund will typically have a lower fund management expense than an actively managed fund.

The Fund House

Who are the promoters? What has been their past experience? How many funds do they manage? What has been the performance of the various funds? Does the fund house enjoy impeccable reputation in the market? Do the key personnel keep changing frequently? The fund manager plays an important role, but he is not the only key person. He may be the visible face, but one must not forget that the behind-the-scenes supporting cast – the management which defines the basic investment philosophy, the parameters & methodology, the research group which identifies the suitable stocks, the sales force, the back-office team etc.    

The Service Standards

How happy has been your investing experience in the past? Or what have been your first impressions about the client servicing? Is the staff courteous? Is the staff helpful? And more importantly, is the staff knowledgeable? Many a times the staff may be eager and efficient in taking your money, but are they equally eager and efficient to give back your money when you need it? Have they delayed your redemption proceeds? Do you get your statements on time? Do they offer other conveniences such as online access to your portfolio, electronic withdrawals & credits etc?

All these will define the service standards, which are also a key factor apart from performance. Not all bright stars of today will remain bright tomorrow; some not-so-bright stars of today may become the bright stars of tomorrow; not all of your choices may turn out to be the best. You win some you lose some.

Source: Moneycontrol

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