Factors before buying a mutual fund scheme

With markets poised to cross the 10,000 mark sooner or later, the question uppermost in the investors mind is where to invest his disposable income. The mutual funds route seems to be the only way to go for retail investors as stock markets are just a little too heated for their comfort.

But, before investing in a mutual fund, there are several factors to be considered, just like any other investment. The right selection of funds and optimal asset allocation mix can help one achieve his financial goals and rash, uninformed investment decisions can completely throw the financial planning train off the rails. So, let us take a look at what factors investors should really contemplate before putting his money in a mutual fund scheme.

The first and foremost is the scheme's past performance, and though no inference should be drawn on scheme's future based on this fact alone, but it is still the best indicator available.

The important thing while evaluating a scheme's performance is not only to consider its point-to point returns vis-à-vis the returns of its peers and the benchmark index, but also the risk undertaken by the scheme to generate that kind of returns. Scheme A may have generated similar kind of returns as scheme B over the same period of time, but the risk taken by the fund manager in Scheme B may be higher, which is measured by the standard deviation, beta or any other parameter. Therefore on risk-adjusted return basis, Scheme B would definitely be a better choice.

Risk- adjusted returns comparison are a much better way of comparing schemes as the investor knows whether the returns generated by the scheme have adequately compensated for the extra risk undertaken by the scheme. The investor depending upon his risk appetite and preferences, thereafter, can look to sub-classify the schemes on the basis of the characteristics of the schemes, which may be defensive or aggressive in nature. A scheme may expose its investors to extra risk and volatility than a normal equity scheme available in the market, therefore the scheme needs to generate higher returns than a normal scheme to justify its overexposure to riskier stocks. A scheme, which fails to do that, should be ranked lower than its peers while comparing them, in a given time frame.

Other important factors which should be considered before short-listing schemes are Portfolio concentration, liquidity and corpus size among others. It is always advisable to choose a scheme, which has a well-diversified portfolio rather than a concentrated portfolio, as it carries lesser risk. A well-diversified portfolio will negate the effect of upswings of a particular company/ sector as its overall impact on the portfolio will be minimal, thereby reducing the volatility of the portfolio. Portfolios can be judged on the basis of company concentration and sector/industry concentration.

Liquidity of the portfolio is also one of the critical parameters. Although, it is not a major cause of worry in Indian mutual fund industry as yet, as the regulators have enough restrictions in place with regard to investments in illiquid securities.

The corpus size of the scheme is also of importance. A large corpus size firstly denotes investors confidence in the scheme and its fund manger abilities over the years and, secondly it allows the fund manager to diversify the portfolio, which reduces the overall market risk. Although there is a flipside as well of having a huge corpus size, which is managing them may become difficult and the fund manager may run out of investment avenues to deploy all the funds, but we feel, the MF industry is yet to enter into that territory where we see single scheme managing extraordinary corpus size. Although, certain schemes recently, have stopped accepting fresh application, to restrict fund size, overall a greater fund size should be considered a plus.

Other factors like turnover rates, low expense ratio, load structure etc of the schemes etc should also be considered before finally zeroing down on a scheme of your choice.

The rankings undertaken by ICRA Ltd. along with its subsidiary ICRA Online Ltd., are an initiative to inform the investors- who does not have the time or the expertise to undertake the analysis on their own- about the relative performance of the schemes. It considers all important parameters as discussed above to arrive at a comprehensive rank with a view to help investors decide the scheme which may suit their investment profile. ICRA Mutual fund Rankings recognizes the industry players who have performed exceedingly well over a period of time, and is into its third year now, and has been well received by the investing community and the industry participants.

Although much neglected, the due diligence in selection of the right mutual fund scheme is of utmost importance as an investor cannot move in and out of a particular scheme on a regular basis, because of the high costs involved, and investments made into a particular scheme should be looked on a long-term basis as a wealth creation tool.