Is the past track record enough to choose a mutual fund?
“Mutual Funds are subject to market risks and past performance is not indicative of future performance.”
Investors are usually ignoramus to this all pervasive disclaimer published in prospectus and propagated in advertisements. Since the start of the stock market bull run in 2003-04, most equity-oriented mutual funds (including new funds launched) have generated a compounded annual return of at least 20 per cent. These attractive returns of the past form the sole basis of investment decisions. Most investors breed unreasonable expectations of such fine performance continuing in the future. This is unfortunately not the case, a glaring example being NAVs of IT stocks falling like nine pins during tech bust.
There are mutual funds which have been around since the 1990s and have weathered the ups and downs of the market over longer periods. Their asset sizes have grown bigger by the day but they have been able to sustain good results. They have a good track record and have built good reputation overtime. Investing in these would certainly provide a comfort level but there are other factors which need to be considered in conjunction with past track records. These are discussed below:
Asset Allocation: This should be the starting point for any investor before he ends up comparing returns of mutual fund schemes. Defining goals (what are you investing for), setting a time horizon for the same and determining risk tolerance levels will enable an investor to do proper fund allocation across different mutual fund schemes. These factors will have a direct impact on the fund being chosen and the return expected. Making realistic goals in accordance with risk appetite and time period of investment is crucial. An investor with a low risk appetite cannot expect an investment of Rs.10,000 to double in a year through a balanced (hybrid) mutual fund. Diversification in terms of fund house is also important. An investor should preferably have not more than two schemes of the same asset management company in his portfolio.
Recent operational changes in a fund: It is advisable to check the recent operational changes in a fund house before investing. The most significant of these are a change of fund manager. The portfolio manager who successfully generated impressive returns of a fund may no longer be managing it. Going along with a new fund manager is synonymous to investing in a new fund offer (NFO). Other important events which may have a bearing on an investor’s portfolio return is a merger with another fund or a change in the investment strategy of the fund.
Examine fund charges: Mutual funds charge investors with fund management fees and various other expenses. The difference is not big between any two equity oriented schemes of the same category. But in case of fixed income funds, the difference in costs can be major even though the difference in returns is marginal.
For e.g, Fund A has an annual expense ratio of 0.5 per cent and Fund B 2.0 per cent. These income funds earn a gross annual return of 7 per cent, each. If you invest Rs.1,00,000 in Fund A, then you receive roughly Rs.1,06,467 at the end of one year. [after adjusting for expenses, net return – 6.5%]. On the other hand, an investment of Rs.1,00,000 in Fund B will fetch you Rs.1,04,901 (net return – 4.9%). Owing to a high expense ratio, Fund B earns Rs.1,566 less compared to Fund A. This is how the cost of different mutual funds can eat into investor returns. And, these can compound to significant variations over a longer period of time.
To conclude, finding a mutual fund which consistently tops the charts is next to impossible. So it is imperative to look beyond a fund’s past performance.
It is equally important to track the investments on a quarterly or half yearly basis. Mutual funds publish monthly fact sheets and quarterly newsletters that contain portfolio information (company wise and sector wise holdings and weightages) and performance statistics on the schemes. Such information is also available on their web sites. Periodically reviewing whether your investments are at least beating the benchmark and the category average will help you to earn the desired return which is consistent with your risk profile.
