How to select an Equity Mutual Fund
Once you have decided to buy a mutual fund, you see that there are plethora of options available and you get confused which fund to go for. We are here to simplify the task for you. Here are some pointers for you to keep in mind when selecting an equity mutual fund.
1. Compare with Benchmark & Category
Returns indeed are an important part of the performance evaluation of the fund. You should check the fund’s returns against the benchmark’s returns and also of the category’s average returns. In India, most of the funds choose a benchmark that is easy to beat; hence the category returns become more important in checking the relative performance.
You should know the ideal investment horizon of your fund and should compare returns of that horizon. For example, a large cap equity fund’s ideal investment horizon is at least 5 years; hence if such a fund is not performing well in short term, you should not worry about that.
2. Risk Adjusted Returns
Risk adjusted returns tell you how much return the fund has provided given the level of risk associated with it. There are many measures (ratios) you can check to find out the Risk adjusted returns of a fund. These are Sharpe Ratio, Treynor Ratio, Alpha, Beta etc. You may read more about these ratios in our Mutual fund Ratios blog.
It is prudent to compare the ratios of similar category funds, then only you will be able to check if your fund is performing better than the funds in the category or not.
For example, let us check the Sharpe Ratio of Birla Sun Life Frontline Equity – Direct plan Growth option.
Sharpe Ratio = (Fund Return-Risk Free Return)/Standard Deviation of the fund
Here we can see that despite similar Standard deviation, the fund has given far better return than the category and hence has a higher sharpe ratio.
Risk adjusted performance ratios are a good measure to gauge and compare the performance of a fund to its category and peers.
3. Upside & Downside performance
Upside & Downside Capture Ratios show how did a fund performed in Bull & Bear markets respectively. Out of these we feel downside capture ratio is more significant. Sometimes a fund performs extremely well in upward moving markets but the same fund loses all its gains and some more in a downward trend resulting in a poor performance. The funds which are able to contain their downside performance tend to do well in long term.
An upside capture ratio of over 100 indicates a fund has generally outperformed the benchmark during periods of positive returns for the benchmark.
A downside capture ratio of less than 100 indicates that a fund has lost less than its benchmark in periods when the benchmark has give negative returns.
Let us take the example of the same fund Birla Sun Life Frontline Equity – Direct plan Growth option.
We can see that the fund has performed in both upward market and downside market.
4. Fund Manager
You may also look into the track record of the fund manager who is currently managing the fund. The past performance and the experience of the fund manager can be used a parameter to choose the fund. If the fund manager of the fund is new, then you may want to wait for some time before opting for the fund.
5. Fund Size
Fund size, i.e. Asset Under Management is also an important factor while choosing an equity fund. A very small fund size can impact fund’s performance in case a large investor exits the fund. This risk is minimized in funds with higher asset size. However, in case you have chosen a small cap fund,then a large fund size will mean reduced investment opportunities and hence the fund’s performance might falter. Hence, check if the fund size is good enough for the category you are investing in.
6. Expense Ratio
A high expense ratio will affect the fund’s return and this can be minimized by going for Direct plans of the mutual funds. Even in direct plans, do check if the expense ratio is lot higher than that of its peers. The high expense ratio of a fund should be justifiable with its returns.
Selecting a mutual fund to invest in might seem a tough task given the large number of funds available. However, if you keep in mind the above steps, it should be easy enough for you. However, the task doesn’t end with only the selection of the fund, a regular review of the performance is also required.
Next read: How to select a debt fund?
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