Home/Article/6 Factors to consider while selecting a mutual fund
6 Factors to consider while selecting a mutual fund
05 Apr 2023

So, finally, you have zeroed in on you allocation to equity and debt funds. The next is the big task of identifying the specific funds to buy. With over 40 AMCs and hundreds of schemes, plans and options on offer, you have a tough choice to make. What are the factors to consider before investing in mutual funds? Is there is a specific metrics of parameters to be considered? What are the things to consider before investing in mutual funds? This is a mix of quantitative and qualitative factors. Here we look at 6 important points for investing in mutual funds. Here is the framework..

 

Does the fund fit into my investment objective?

This is the most critical factor to consider. The fund that you select must fit into your overall investment objective. Are you trying to adopt a conservative or aggressive approach to investing? What are the objectives of the fund and has it been consistent in sticking to these objectives. For example, if you are invested in a debt fund for stability and income stream, then there is no point in buying a debt fund that adopts a more dynamic approach to rates management. Similarly, if you are looking at equity performance at par with the index then you are better off with index funds. Why take the risk of equities and the higher expense ratios of diversified equity funds?

 

How has the fund performed in risk-adjusted terms?

We all know that the past is not an index of the future but when it comes to mutual funds consistency of past performance matters a lot. 15% return with low volatility is more preferable and attractive compared to 17% returns with high volatility. You need funds that outperform the index funds over a longer period of time otherwise you are better off staying invested in passive funds like index funds and ETFs. More importantly, also look at returns in risk adjusted terms. That is where the Sharpe and Treynor ratio come in. 16% return with acceptable risk is better than 19% return with high risk.

 

Experience and longevity of the fund management team
You may wonder as to why longevity of the fund management team matters? The answer is that it brings about consistency in investment strategy and a better sync between the dealers, traders, researchers, the CIO and the CEO. Typically, fund managers stay on in a fund if they are happy and if the fund is performing well. Otherwise, fund managers keep looking for alternate opportunities. You will find that funds that perform better over a longer time period are the funds that have had stable fund management teams. This ensures continuity of fund decision making.
 
How much is the fund loading on to you

There are some costs that are billed directly to you and there are other costs that are billed to your NAV in the form of expense ratio. In the past there were entry loads, which are not applicable any longer. But exit loads are still charged to you at the time of exit if you exit a fund before the stipulated period. Then there are costs like transaction costs for the fund, operational costs, administrative costs, marketing costs etc which tend to get debited to the NAV of the fund. Fund managements are required to explicitly disclose the expense ratio and the break-down in a transparent manner. Equity funds have an expense ratio of 1.5-2% while index funds have much lower expense ratios. Compare the returns of the fund vis-à-vis the expense ratios.

 

What are the exit loads and the tax implications?

These are broadly applicable to all the funds you choose but it important to understand the implications of these. For example, if you sell equity funds before a period of 1 year they attract STCG tax at 15% while debt funds sold before 3 years will attract STCG tax of 30% (peak rate). Similarly, equity funds LTCG gains were tax-free but from April 01st 2018 any gains in excess of Rs.1 lakh will be taxed at a flat rate of 10% without the benefit of indexation. Also look at the exit loads applicable which may range from 0.5% for larger funds to 1% for smaller funds. They make a difference to your return on investment.

 

Has the fund been ahead of the investment curve?
This is a qualitative judgement but you need to do this analysis before investing in a fund. Has the equity fund manager managed to move into winners early and move out of losers early? Your fund manager may not catch every trend in the market but as long as he catches the key trends it is good. In case of a debt fund, has your fund manager been able to tweak the maturity of the portfolio based on interest rate expectations. In case of hybrid funds, has your fund manager handled the mix of equity and debt smartly? The bottom-line is that the fund management should be ahead of the curve; that is what differentiates a good fund manager from an average fund manager.
 

Checkout more Blogs

You may also like…

Get Exclusive Updates

Be the first to read our new blogs

Get Expert financial insights and advice for informed investment decisions.

Intelligent investment insights delivered to your inbox, for Free, daily!

Take your next step

Open Demat Account
I wish to talk in South Indian language
By proceeding you’re agree to our T&C
setTimeout(function() { }, 5000);