"Mutual Fund Sahi Hai" - But which one?

“There are so many mutual funds! How should one decide which one to invest in?”?

There is no simple answer to this question. Like many other investments, there are a number of factors that should be considered in deciding on the ‘right’ mutual fund for a given investor.

This article discusses the various types of mutual funds and the main factors that may be considered when investing in them.?

1.????Categorisation of mutual funds

To begin with, one must be clear about the different types of mutual funds available in India.?Given below is a summary of how the various mutual funds could be categorised and what each of them means.

2.????Reputation of the mutual fund house / Asset Management Company (AMC)

After deciding on the category of mutual fund to invest in, the next step is to decide on the mutual fund house (i.e. the Asset Management Company) which offers the various funds.

Although all the AMCs are governed by the Securities and Exchange Board of India (SEBI) and therefore, may be considered to be appropriate for investment by retail investors, individuals may have their views / preferences about specific AMCs / fund houses based on their general reputation, service standards, overall experience in the market etc.

For ease of regular monitoring, it is better to stick to mutual funds offered by 3 or 4 large AMCs of good repute, instead of investing in mutual funds offered by too many AMCs.?

3.????Experience / expertise / reputation of the investment manager

This is, arguably, one of the most important factors to consider as it is the knowledge, skills of the specific investment manager that would ultimately decide the overall investment returns achieved by any mutual fund.

For a layman, however, this is a difficult aspect to consider even though most of the AMCs would publish the detailed CVs of their investment managers on their website.?Nonetheless, one should look through the CVs of the concerned investment manager(s) to assess their experience in investment management.?

4.????Total Expense Ratio (TER)

This is the sum of FMCs and other expenses charged to the mutual fund by the AMC, expressed as a percentage of AUM.?Naturally, all other things being equal, funds with a lower TER would deliver a higher investment return to the investor.

5.????Level of assets under management (AUM)

Given that for a layman, the experience / expertise of the investment manager is relatively difficult to form an opinion on, one should also consider the level of assets under management (AUM) in the given fund. This would help as follows:

• A fund with high level of AUMs is likely to be managed by an investment manager with significant experience / expertise (instead of by a relatively inexperienced / junior investment manager).
• Large AUMs may also suggest that the fund has been in existence for a longer period and thus is expected to be well-established and is preferred by other investors.?
• The maximum TER that can be levied by the mutual funds also depend on the size of the AUM.?The larger the AUM, the lower the maximum permissible TER.?

Considering these, one may invest in mutual funds that have an AUM of at least Rs.5,000 Crores in the current scenario.?

6.????Historical investment returns against benchmark

All actively managed mutual funds would disclose a benchmark against which the actual performance of the fund may be assessed.?It would be important to review the historical investment returns delivered by the fund against the set benchmark.?One should avoid investing in a fund that has consistently under-performed as compared to its benchmark.

Mutual funds would also disclose the historical investment returns actually delivered – over the past 1 year, 3 years, 5 years, since inception etc.?Although future investment returns will certainly not depend on the actual historical investment returns delivered, it would be useful to consider the historical investment returns simply to get a feel for the overall level and variability that may be expected in the future.

7.????List of top 10/20 stock / bond holdings

One may also wish to review the top-10 or top-20 stock / bond holdings of the mutual fund, to ascertain if there are any stocks / bonds of companies that are widely known to be in financial difficulty and hence might impact the future performance of the concerned mutual fund.

Some individuals may also want to avoid investing in certain companies (even indirectly through the mutual fund route) for personal / religious reasons.?Considering the actual stock / bond holdings of the mutual fund helps an investor gain that perspective.

Having considered these factors, one may decide on a maximum of 4 or 5 mutual funds to invest in.?Again, too many mutual fund investments may make their regular monitoring rather cumbersome.

It is important to monitor all these aspects regularly. As personal circumstances change and also the factors impacting the various mutual funds change, one may have to re-balance / re-shuffle some of the mutual fund holdings.??Of course, this doesn’t mean reacting to each and every news in the short-term, as one should really be investing for the long-term and with specific investment objectives in mind. However, it does mean that consistent adverse performance of any mutual fund investment may need to be looked into and corrective steps taken, if necessary.

Happy investing!