How to choose a Mutual Fund?

Once you’re ready to choose some mutual funds, there are ways to analyze them such as looking at each fund’s past performance history, management team, and expense ratios. You can also entertain different investment strategies that will drive your fund choices, such as diversifying your portfolio with international exposure, buying the market index , or rupee-cost-averaging your money into different funds

Goal: As an investor, you’ll have upwards of 10,000 mutual funds from a plethora of fund management companies to choose from, so it helps to set some goals to narrow the field. Ask yourself the following questions to gain some clarity on your investing goals:

Are you looking for current income or long-term appreciation (capital gains)?

Does the money need to fund a college education or accumulate for a far-off retirement?

In terms of risk tolerance, it’s important to decide where you sit on the risk continuum:

Can you tolerate a portfolio that may have extreme ups and downs?

Are you more comfortable with a conservative investment strategy?

Finally, think about the best time horizon for your investments, or how long you need to invest your funds:

Do you need your funds to be liquid in the near future?

Are you investing money that you can afford to have tucked away for many years?

If you invest in mutual funds that have sales charges, they can add up if you’re investing for the short term. An investing term of at least five years is ideal to offset these charges.

Benchmark:Each fund has a different approach and goal. That’s why it’s important to know what you should compare it against to know if your portfolio manager is doing a good job. For example, if you own a balanced fund that keeps 50 percent of its assets in stocks and 50 percent in bonds, you should be thrilled with a return of 10 percent even if the broader market did 16 percent. Adjusted for the risk you took with your capital, returns were stellar.

Expenses :it is the cost of owning the fund. Think of it as the amount a mutual fund has to earn just to break even before it can even begin to start growing your money.

All else being equal, you want to own funds that have the lowest possible expense ratio. If two funds have expense ratios of 0.50 percent and 1.5 percent, respectively, the latter has a much bigger hurdle to beat before money starts flowing into your pocketbook. Over time, these seemingly paltry percentages can result in a huge difference in how your wealth grows. 

Diversification: What is considered good diversification? Here are some rough guidelines:

Don’t own funds that make heavy sector or industry bets. If you choose to despite this warning, make sure that you don’t have a huge portion of your funds invested in them.

Don’t keep all of your funds within the same fund family. By spreading your assets out at different companies, you can mitigate the risk of internal turmoil, ethics breaches, and other localized problems.

Don’t just think stocks. There are also real estate funds, international funds, fixed income funds, arbitrage funds, convertible funds, and much, much more. Although it is probably wise to have the core of your portfolio in domestic equities over long periods of time, there are other areas that can offer good returns.

Fund manager tenure and experience :  Fund manager plays a very important role in the fund’s performance. Though it is a process oriented approach but still fund manager is the ultimate decision maker and his experience and view point counts a lot. You should know who is the fund manager of the scheme and what is his past track record. You should also look at the performance of other funds which he is managing. If the fund manager of the scheme has recently been changed, don’t panic.  Just keep a watch on his performance by looking at alpha and quarter to quarter performance. If you find that due to change in the fund manager there is considerable effect on the fund’s performance which does not suit your risk appetite then you may make a decision to exit. 
 
Scheme asset size : This parameter is different for debt and equity schemes. In equity the comfortable asset size in hundreds of crores, in debt it should be in thousands of crores as the investment value per investor is higher in debt funds. 90 percent of total assets under management (AUM) of the mutual fund industry are invested in debt funds, so your selected scheme assets should also have a considerable AUM. Less AUM in any scheme is very risky as you don’t know who the investors are and what quantum of investments they have in this particular scheme. Exit of any big investor out of any mutual fund may impact its overall performance very badly and the remaining investors in a scheme will have to bear the impact.  In schemes with larger AUMs this risk gets minimised.    You must have observed that all the above mentioned parameters are overlapping each other in some way or the other. A good fund manager will automatically result in better performance and thus improve the quartile ranking and would also generate good alpha. High scheme assets will help in reducing the total expense ratio of the scheme.