Everyone knows the power of mutual funds. It's the best and the most effective tool for wealth creation. A disciplined investment in a mutual fund via Systematic Investment Plan (SIP) can turn all your long-term and short-term financial goals into reality. Though we have understood the importance of mutual funds it still remains an extremely complex concept to understand. If you want to invest in a mutual fund you will be confronted by questions like - direct or regular? Dividend or growth? Equity, debt or hybrid? Eventually, you have to seek help and go along with what your financial advisor suggests. This is not to suggest that seeking help from an expert is wrong. In fact, it's the smartest way to manage your investment. However, it is always good to have the working knowledge of the instruments you are investing in.
Let's take a look at things that you need to check before investing in any mutual fund.
Check Out The Performance Ranking
More than the performance of any mutual fund its ranking should be the first thing you look at. You can do this by checking the quartile ranking of any fund. Quartile ranking provides a clear idea of how the fund has performed on the quarter on quarter basis among its peer group. Each quartile contains 25 percent of all the funds. If a fund remains in the top quartile most of the time it is a clear indicator that the fund is performing well. Also, keep checking the performance of your fund periodically. If your fund is out of the top 25% repeatedly it means that it's time to move to a better fund. You can find all the data and the rankings in the factsheets that all the Asset Management Companies (AMC) publish on their websites. Sites like Moneycontrol and Value Research Online have all the data.
Watch The Ratios & Alpha Of The Fund - Ratio analysis is extremely critical. Check out the ratios like standard deviation and Sharpe ratio to get an insight of the fund. This activity also helps to narrow down your options. Along with ratios analysis, always ensure that you check the ALPHA of the fund. Alpha is an indicator of the fund manager's performance. It shows how the fund manager has given returns out of a given portfolio compared to the fund's benchmark. In simple words, alpha is the performance rating of the fund manager. It provides an indication of how often the fund manager has produced positive alpha in last few quarters.
Total expense ratio - Expense ratio is an important thing which you have to look at while reviewing any fund. The expense ratio is the ratio of all the expenses that the process of fund management and distribution causes. Higher expense ratio means the AMC is spending too much money on operational activities and it will eventually have to borne by the investors. To put it simply, high expense ratio will hamper your returns. To regulate the expense ratio, SEBI has capped mutual funds total expense ratio. As an investor, it is always better to choose a fund with lower expense ratio.
Who’s The Fund Manager? - A fund manager is the captain of the ship. He plays a critical role in how the fund performs. Managing a fund is a process-oriented approach, but a fund manager brings his/her personality and financial discipline to the fund. He/she is the final decision maker for all the buying and selling that goes into the fund. As the fund manager plays such decisive role, SEBI has made it mandatory for all the AMCs to disclose the names of the fund manager in the fund's factsheet. As a responsible investor, you should always be well-informed about who is the fund manager of your fund and his/her track record. It helps to analyse the performance of the funds that he/she has managed or is currently managing. You needn't panic if the fund manager of the fund has recently been changed. Such reshuffles keep happening in all the fund houses. However, if you feel that due to a change in the fund manager there is a notable change in the fund's performance then you consider exiting the fund.
Size Matters - Bigger The Better - The asset size of the fund makes a lot of difference. The bigger the size of the fund better it is for the investors. The fund size of debt and equity funds have a huge difference. Debt funds usually have thousands of crore of the asset under management (AMU) while for an equity fund with a few hundred crores is considered good size. In fact, 90 percent of total assets of the mutual fund industry is invested in the debt market. The point is that your scheme's assets should have a considerable AUM. Less AUM in any fund is deemed risky as you have no knowledge who the investors are and what is their quantum of investments in the scheme. If any big investor exits the fund there is a possibility that it might hamper the performance of the fund. Whereas the funds which have a bigger AUMs can easily absorb such bumps.