Investing in mutual fund is a popular choice for individuals. It provides diversified and professionally managed investment portfolio. Assessing the performance of mutual fund is a critical aspect of successful investment management. By the assessing the performance of your mutual fund one can gain valuable insights in to the effectiveness of your investment strategy and make informed decisions of financial future.
Let us understand how to evaluate equity mutual fund
- Know about the funds
These schemes invest most of the money gathered from investors in to the stock market and the risk level in equity mutual fund are quite high. Investors should invest in these funds as per their risk appetite. SEBI has defined three categories as per market capitalization. Market Capitalization is calculated by multiplying the number of outstanding shares a company offers with the current market price of the share. The three categories are
- Large Cap : Top 100 Companies in terms of market capitalization
- Mid Cap : 101st- 250th companies in term of market capitalization
- Small Cap: 251st company on wards in terms of market capitalization
S.NO. | Category of Scheme |
|
1 | Mid Cap Fund | These schemes invest in companies that rank between 101 and 250 in terms of market capitalization. These funds are considered to be less risky than small-cap equity funds but riskier than large-cap equity funds. However, mid-cap stocks tend to offer better growth potential than large-cap stocks. |
2 | Small Cap Fund | These schemes invest in companies that rank above 250 in terms of market capitalization. These funds are considered to be riskiest compared to large- or mid-cap equity funds, but also have the potential to deliver the highest returns. |
3 | Large-Cap Fund | As per the SEBI guidelines, these schemes invest in companies who rank between 1 and 100 in terms of market capitalization. Large-cap equity funds are considered to be the least risky investments compared to other types of equity mutual funds. What’s more, they are also known to offer stability and sustainable returns over time |
4 | Multi-cap Fund | Multi-cap equity mutual fund schemes invest in stocks across all market capitalizations, i.e. small-, mid-, and large-cap companies. The fund manager decides the proportion of these investments according to prevalent market conditions. These funds are generally meant for investors who do not want to be restricted to any particular industry while simultaneously seeking exposure across the market. |
5 | Large and Mid-Cap Funds |
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6 | Dividend Yield Funds | Predominantly invest in dividend yielding stocks, with at least 65% in stocks |
7 | Value Fund | Value investment strategy, with at least 65% in stocks |
8 | Contra Fund | Scheme follows contrarian investment strategy with at least 65% in stocks |
9 | Sectoral/Thematic Fund | At least 80% investment in stocks of a particular sector/ theme |
10 | Focused Fund | Focused on the number of stocks (maximum 30) with at least 65% in equity & equity related instruments |
11 | ELSS | At least 80% in stocks in accordance with Equity Linked Saving Scheme, 2005, notified by Ministry of Finance |
Assessing the strength of a mutual fund’s portfolio is crucial in analyzing its performance. Here are some key factors to consider:
Asset allocation: Examine the fund’s allocation across different asset classes such as stocks, bonds, cash, and alternative investments. A well-diversified portfolio can help manage risk and potentially enhance returns. Ensure the fund’s asset allocation aligns with your investment goals and risk tolerance.
Sector and industry exposure: Evaluate mutual funds holdings to determine their exposure to various sectors and industries. A balanced allocation across sectors can help mitigate concentration risk. Assess whether the fund’s sector exposure aligns with your investment objectives and reflects your views on different industries.
Quality of holdings: Evaluate the quality of the individual securities held by the fund. Look for strong companies with solid financials, competitive advantages, and growth potential. Assess the fund’s holdings based on factors such as market capitalisation, credit ratings, and the fund manager’s investment thesis.
- Return Generation Check
Calculating mutual fund returns is a good idea as it will provide you with an idea about how much you have earned from your investments. The formula for manually calculating the returns from a fund is as follows:
M = P (1 + r/100)^n
Here,
- M = Amount you will receive after the fund’s maturity
- P = Principal amount
- r = Returns rate on investments
- n = Holding period of investments (in years)
The mutual fund calculator is a simulation that helps you to calculate the returns from the mutual fund investments. You can calculate the maturity value of an investment if you invest a lump sum amount or even through the SIP route.
A mutual fund calculator is an easy to use tool that helps you to get an idea of the maturity value of the mutual fund investment, even before you invest the money. It allows you to budget for expenses and achieve your financial goals, as you already know the amount of money you will get at maturity. You can enter the SIP amount, duration of the SIP, and the frequency of the SIP to calculate the maturity amount for an estimated rate of return on the investment.
The mutual fund calculator has a formula box where you select the nature of the investment. It can be a lump sum investment or a SIP investment. You select the amount of investment, rate of return and the duration of the investment to get the maturity amount. If the nature of the investment is a SIP, you select the SIP amount, frequency, time of the investment, and the expected rate of return. The mutual fund calculator shows you the value of the investment at maturity.
Before you invest in a mutual fund scheme, it is a good practice to assess your return on investment. For doing so, a mutual fund calculator is the best tool as it is simple and easy to operate. Even if you are using it for the first time, you will not encounter any troubles.
- An MF calculator will provide you with the total estimate for 1, 3 and 5-year investment horizons.
- It assists you in planning your future financial strategy based on the estimated returns.
- Risk Return Relationship
While looking at a mutual fund scheme’s performance, one must not be led by the scheme’s return in isolation. A scheme may have generated 10% annualized return in the last couple of years. But then, even the market indices would have gone up in similar way during the same period. Under-performance in a falling market, i.e. when the NAV of the scheme falls more than its benchmark is the time when you must review your investment.
One must compare the scheme’s return as against its benchmark return. It is better to be rid of investment in a scheme that consistently under-performs as compared to its benchmark over a period of time, from one’s portfolio. It is important to identify under-performers over the longer time horizon in addition, one may also consider evaluating the ‘category average returns’ as well. Even if a scheme has outperformed its benchmark by a decent margin, there could be better performers in the peer group. The category average returns will reveal how good is one’s investment is against its peers which help in deciding whether it is time shift the investment to better performers.
One may be holding a too little or too much-diversified portfolio. Even the expense ratio of some of the schemes that one could be holding may be high compared to others within the same category. Most importantly, the review helps an investor validate if the investments are aligned to his/her goals.
- Ratios to be checked
Fortunately, there are ratios that already exist and calculate the risk and volatility of any mutual fund portfolio. This will not only give you a better understanding of risk and volatility, but also help you choose a better fund when you are looking at various mutual fund offer documents.
Alpha
Alpha gives a measure of the risk adjusted performance of your investment. Simply put, it will give you an idea of the excess returns that your invested fund may generate, compared to its benchmark. For example, if a mutual fund scheme has an alpha of 5.0, it usually means that the fund has outperformed its benchmark index by 5%. It can be seen as the additional value the mutual fund manager adds or takes away from the return on your portfolio. Alpha can be negative or positive.
Let’s say you invest in a mutual fund XYZ, having BSE Sensex as its benchmark. Let’s further assume that BSE Sensex that has given a return of 20% in a specific year. If the given value of alpha is positive 2.0, then it means that XYZ has outperformed its benchmark index by 2% and given 22% as returns for that specific year. Similarly, a negative alpha of 2.0 may mean that XYZ has underperformed compared to BSE Sensex and given 18% as returns for the specific year.
Beta
Beta denotes the sensitivity of the mutual fund towards market movements. It is the measure of the volatility of the mutual fund portfolio to the market. When you are looking at the beta of a mutual fund, you are finding out the tendency of your investment’s return to respond to the ups and downs in the market. Here, the market usually refers to the benchmark index the fund follows. The beta of the market or benchmark is always taken as 1. Any beta less than 1 denotes lower volatility and higher than 1 denotes more volatility compared to the benchmark index.
For example, if your mutual fund portfolio XYZ has a beta of 0.70, it denotes lower volatility. This means that for every rise or fall of 1 in the market, the value of XYZ may rise or fall by 0.70. If you have a low to medium risk profile, then you should look at funds having a lower beta value. Further, when looking at beta, it always preferable to also check how closely your mutual fund portfolio mirrors the benchmark. This correlation can also be seen by a ratio called R-Squared. R2 or R-Squared is a statistical measure that explains to what extent the portfolio movement mirrors the movement by the benchmark index. The values of R-Squared lie between 0-100. The value of R-Squared needs to be higher than 80 to indicate a high correlation of benchmark and the mutual fund portfolio. Beta may not be so effective in case your portfolio doesn’t closely follow the benchmark.
Standard Deviation
Standard deviation is a statistical tool that measures the deviation or dispersion of the data from the mean or average. When seen in mutual funds, it tells you how much the return from your mutual fund portfolio is straying from the expected return, based on the fund’s historical performance. For example if the portfolio XYZ has a standard deviation of 7% and average return of 15%, it means that it has a tendency of deviating by 7% from its expected average return and may give returns between 8% to 22%. Standard deviation is directly proportional to the volatility of the portfolio. It is also used in calculating Sharpe’s Ratio.
Sharpe’s Ratio
The Sharpe’s ratio uses standard deviation to measure a mutual fund’s risk adjusted returns. It will tell you how well your mutual fund portfolio has performed in excess of the risk-free return. This essentially gives you an idea if your returns are due to smart investment decisions or excessive risk. Higher the Sharpe’s ratio, better the risk adjusted return of your mutual fund portfolio.
You can combine the inferences from the above methods of measuring risk with information like the fund history, past performance and expense ratio to identify the best-suited mutual fund schemes for your portfolio and your risk profile.
Conclusion
Thus before investing in mutual funds do evaluate following points carefully
- Start with equity mutual fund research with basic hygiene check so that you know more about the fund
- Know about the fund history through its previous track records
- Look for rolling returns of the fund on 3,5 and 10 year basis
- Compare the rolling fund with its benchmark.
- Check the risk and return relationship with the help of ratios.
