One of the big challenges that you will face in picking a mutual fund is the surfeit of choice available. With over 40 AMCs, over 1000 funds and more than 2000 schemes on offer, you are truly spoilt for choice. So, how to pick a winning mutual fund and create a winning mutual fund portfolio. Here are10 steps to select winning mutual funds. For simplicity, we shall call it the 10 tips to pick really solid mutual funds in your portfolio.
10 tips to pick winning mutual funds in your portfolio:
Historically, good funds have given attractive past performance. Any mutual fund in its risk factors will tell you that past performance is not guarantee of future performance. However, it is seen in most cases that good funds manage to outperform in most market conditions. At least they manage to outperform in the long run.
It is not just returns but consistency of returns that also matters. Consistency is quite simple. A fund that generates 13%, 14% and 15% has given the same CAGR returns over 3 years compared to another fund that has generated 5%, -4% and 47% over 3 years. But, it needs no reiteration that the first fund is a lot more consistent. Consistent funds tend to be more predictable.
Another important facet of mutual fund selection is how well it fits into your long term financial plan. The fund must be best for you in terms of returns, risk, liquidity and tax efficiency. The best funds are pointless if they don’t help you meet your goals. That is why fund is a very individualistic selection.
What has been the risk associated with the fund. Earning 15% returns in an equity fund is great but you need ask what risk has been assumed in the process. A fund that generates 14% returns with 10% volatility is far better than a fund that gives 16% returns with 40% volatility. In terms the risk adjusted returns, the first fund is a lot better. You can plot risk adjusted returns with Sharpe and Treynor ratios.
Is the fund management team consistent over time. You should avoid a fund that is seeing a lot of churn in senior personnel like CEO, CIO, fund managers etc. That is not very favourable for consistency of investment policy and long term performance. Ideally, the best funds are the ones that have a consistent and long standing top management team in place. There is a lot more continuity that way.
Prefer a fund that is based a lot more on process and rules that a fund that is based entirely on the discretion of the fund manager. The fund manager is human after all and hence prone to errors. If the fund manager is having full flexibility on everything right from dynamic asset allocation, then you are leaving too much at the mercy of the fund manager. That is not advisable.
Costs are important and they are damned important. A 1% reduction in costs each year can make a valuable difference to you returns over a longer period of time. Remember, TER gets debited to your NAV on a daily basis and hence lower costs means that returns will be higher. Of course, equity fund TER will be more than debt funds, which in turn will have higher TER than liquid funds. Within a category, prefer funds that have a higher AUM since the impact will be lower on your NAV.
Monitor your funds on a regular basis. Your job is not done with putting your money into the fund. The concept of “Invest and forget” is not in your interest. When you get the fund fact sheet each month check the fund manager commentary, the actual returns, the variance in returns, the portfolio mix etc. They can give you a lot of insights.
Evaluate the cost of exit before taking an exit decision. For example, occasional under performance is par for the course. But if the cost of exit loads plus taxes plus liquidity costs are too high then the basic purpose is defeated.
The most important step in picking the best mutual funds is to focus on getting the mutual funds that fit into your needs. Once that is done, the second step is to evaluate alternate options. You need to create a mutual fund portfolio that has the right mix of equity funds, debt funds, liquid funds, variable funds etc. This mix needs to be tweaked consistently based on the external and internal stimuli.
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