How to select an appropriate MF Scheme for Investment

Mutual Funds investing is one of the best options an investor has to take exposure in different asset classes. The investment arena where MF schemes invest may be far away from reach of small investors due to the paltry sum they have. However, this mode of investment has given them benefits which are required for a wise investing-Diversification, Professional management and Liquidity being the major one.

However, with more than 30 AMCs operating now and more than 1000 schemes’, selecting a good mutual fund scheme to invest is a daunting task for investors. Due to lack of awareness and aspirations of AMCs along with distributors, most of the investors end up making the wrong choice. I personally know an investor who is 64 years of age and do not have any knowledge of this investment vehicle. Advice from his distributor made him invest in 38 NFO schemes and even after five years he is yet to make money. All along this his distributor has taken home a good income to host a party for the team.

Hence mutual fund investing is not a five minute decision but you require a good research to choose the good scheme which can meet your criteria. Setting some parameters and selecting on basis of them is always a good approach. Here I have listed some basic ones which you should consider before signing the cheque to give to your advisor:

     1. Your Goal: Identification of goals is the first step towards investing in a mutual fund. A financial planning approach lay stress on this parameter before you do any investment planning. Goal identification helps you in knowing the time horizon of your investment which in turn helps you in choosing the right asset class to invest. For example if it’s  a long term goal like children’s planning or retirement where you have 15-30 years, investing in asset class like equity would be a viable option. However if you have only 2-3 years to reach out your goal then FMPs, FDs or even MIPs make the most of your investment. Hence, setting financial objectives becomes the key for choosing any asset class around which a particular MF scheme create its portfolio.

     2. Returns: Many a times investors gets attracted by the top performing scheme on basis of 1-2 year returns and lounge for it. However, it’s not necessary that a scheme which has performed for 1-2 year will last for years going ahead. When you look at returns two factors are most important-Consistency and Downside protection. Any scheme which has passed through the worst market falls of 2000 and thereafter will be a good scheme to invest if they have been able to protect their downside. HDFC Top 200, Birla Sunlife Frontline Equity and DSPBR Top 100 Equity are schemes which all advisors and financial planners recommend because of their consistency in performance even in the bad markets. Contrary to this fund from JM Mutual Funds has been killed during market fall. Hence, look for these two parameters discussed above to judge a scheme on basis of returns.

      3. Financial Ratios: There are some well-known financial ratios which you can find in the fact sheet of a mutual fund scheme. These ratios give you some analysis of a mutual fund scheme. For example beta of a mutual fund scheme gives the sensitivity of the fund wrt to its benchmark/index while standard deviation of a mutual fund scheme gives you volatility of a fund wrt. its mean return. You have Sharpe ratio which gives you risk adjusted return of a fund and there is portfolio turnover ratio which analyses how frequent the scheme has churn its portfolio. By using these ratios in your analysis you can judge whether a mutual fund scheme will be able to sustain the performance. However do note than the ratios individually will not give you a right estimate. For e.g. a high portfolio turnover ratio does not means the fund is not right to invest. A combination of these ratios in your analysis can make your research more accurate. Other ratios which can be helpful in your research are R-Squared, Alpha and Trey nor Ratio.

      4.  Expense Ratio: It is also a very important ratio which has an impact on the returns you earn from the scheme. It states how much you pay a fund in percentage term every year to manage your money. The expenses deducted goes towards fund management fee, agent commissions, registrar fees, and selling and promoting expenses.  For example, if you invest Rs 10,000 in a fund with an expense ratio of 1.5 per cent, then you are paying the fund Rs 150 to manage your money. In other words, if a fund earns 10 per cent and has a 1.5 per cent expense ratio, it would mean an 8.5 per cent return for an investor. The higher expense ratio in long term can eat into the scheme returns due to compounding effect.  However, it does not necessarily indicate all schemes with lower expense ratio will be good ones. A good fund will deliver will have good returns and minimal expenses. Hence make this one of your parameters but do not judge solely on basis of this.

      5. Fund Manager: Entry or exit of a fund manager can sometime lead to heavy variation in the scheme performance if it rely heavily on his/her stock picking abilities.JM Mutual Fund is a classic example of heavy reliance on Sandeep Sabharwal whose entry lifted the schemes to the top category and since his exit the AMC has been on the downward trend. Check the fund manager track record. How he has performed in the past during good times and in falling markets. Long Association of a fund manager with any company helps in delivering consistent performance. HDFC, Birla, DSP and Franklin Templeton funds consistent performances has been due to the same reason. However, in longer term a good mutual company will become a process driven company and the fund manager exit impact will be minimized

     Analyzing a good MF scheme, from 1000 present, for a layman is very difficult. But some of the basic parameters like Goal Setting, Returns and fund manager track record are easy to understand & the information is available widely. In case investors find it difficult to understand the financial ratios, it’s advisable to take the help of a good financial planner. Do note that sometimes a good scheme can lose sheen after performing for many years. Reliance growth and Vision are good examples. Hence it’s necessary that even after selecting a MF scheme for investment, it should be tracked and reviewed regularly so that any changes like mentioned above can be easily noticed and right action can be taken by the investors.