How to analyse mutual fund performance – 7 Key factors

With thousands of mutual fund schemes across various categories to choose from, selecting the right mutual fund to invest in can be an overwhelming task for investors. One of the key aspects to thoroughly analyse when choosing a mutual fund is its past performance across multiple parameters. But that’s not the only factor to consider. Here are 7 important factors you should evaluate in detail to assess and compare mutual fund performance.

1. Returns

The most basic metric to assess mutual fund performance is its historical returns. This refers to the total gain or loss made on the investment over a period of time, usually expressed as a percentage. There are a few types of returns that must be analysed:

• Absolute returns: This measures the total percentage gain or loss in the mutual fund’s Net Asset Value (NAV) over a specific time period. For equity funds, analyse absolute returns generated over 3-year, 5-year and 10-year periods or since inception if the fund is younger.
• Annualised returns: While absolute returns give the total gain or loss, annualised returns measure the compounded annual gain or loss in NAV over the time period invested. Annualised returns allow you to make an apples-to-apples comparison of returns across funds even if the duration of investment is different.
• Benchmark Returns: An important aspect is to compare the fund’s performance to its benchmark index over the same time period. For equity funds, benchmark indices are typically market indices like Nifty 50 or BSE Sensex. This allows you to see if the fund has outperformed or underperformed the broader market.

2. Risk-adjusted returns

While high absolute returns may seem attractive, it is also crucial to evaluate the amount of risk taken by the fund manager to generate those returns. The best-performing funds are able to maximise returns for every unit of risk taken. Some key risk-adjusted return metrics you should analyse are:

• Sharpe ratio: This measures the excess return earned over the risk-free return, per unit of risk taken. The higher the Sharpe ratio, the better the risk-adjusted returns.
• Sortino ratio: This is a modification of the Sharpe ratio that differentiates between good (upside) and bad (downside) volatility. It evaluates risk through the downside deviation in returns only. A higher Sortino ratio indicates better returns for the downside risk taken.
• Alpha: This measures the excess return generated by the fund over and above its benchmark. A higher alpha indicates that the fund has outperformed its benchmark index after accounting for risk.

3. Consistency

The best-performing mutual funds are able to consistently generate good returns across full market cycles – both bull and bear phases. Hence, it is important to analyse and compare mutual fund performance consistency. Consider:

• Rolling returns: Analyse year-by-year or monthly returns rather than just point-to-point returns to assess consistency.
• Volatility: Calculate the standard deviation or volatility of fund returns. Lower volatility indicates more stable and consistent returns over time.
• Downside protection: Evaluate how well the mutual fund contained declines during market downturns.

4. Fund manager track record

The fund manager plays a pivotal role in shaping the mutual fund’s performance. Hence, it is vital to evaluate the track record and investing style of the fund manager managing the scheme.

• Past performance of managed schemes: Analyse the returns generated across other schemes managed by the same fund manager. Consistency indicates an established track record.
• Manager tenure: A longer tenure of the fund manager managing the scheme indicates more experience across different market conditions.
• Manager style: Study how the fund manager invests – value, growth, large-cap bias, multi-cap, etc. It should match your investment objective and risk appetite.
• Benchmarks managed: Has the manager demonstrated skill managing different benchmark indices like Nifty 50, BSE Midcap, etc.?

5. Underlying portfolio

The composition and characteristics of the mutual fund’s underlying portfolio and stocks also impact its risk-return profile.

• Market capitalisation: Analyse the exposure to large-cap, mid-cap, and small-cap stocks. Match it to your own risk appetite.
• Sector allocation: Understand sectoral exposure to financials, information technology, FMCG, pharma, etc., and their weightage in the portfolio.
• Individual stock exposure: Is the portfolio diversified across many stocks or concentrated in a few stocks?
• Valuation metrics: Evaluate if the portfolio has a value or growth tilt based on the average price-to-earnings and price-to-book ratios of the underlying stocks.

6. Costs and fees

While returns are important, costs and fees can also substantially impact long-term returns. Ensure that the costs charged by the mutual fund are reasonable and justified by its performance.

• Expense ratio: This is the annual fee charged as a percentage of assets to manage the fund. It includes fund management fees.
• Exit load: This fee may be charged when redeeming units based on tenure. Analyse the lock-in period and the exit load structure.
• Transaction costs: Portfolio turnover leads to brokerage, spread costs, etc., that impact returns.
• Taxes: Understand the tax implications of investing in a specific fund.

7. Fund house reputation

While evaluating a mutual fund, the overall quality, transparency, and service standards of the Asset Management Company (AMC) also count. Look at parameters like:

• Assets Under Management (AUM): This signifies the size and scale of operations.
• Investment philosophy and values: Does it align with your beliefs?
• Research capabilities: Consider the robustness of the AMC’s equity and macro research.
• Customer service: Take into account the AMC’s grievance redressal, query resolution, digital platforms, etc.
• Corporate governance: Quality of compliance, risk management, and audit and accounting standards also matter.

Conclusion

Past returns alone do not accurately indicate future performance. Considering parameters like risk, consistency, costs, fund manager track record, and portfolio style and characteristics along with returns is vital to make an informed investment decision. This mutual fund analysis should also be reviewed on an ongoing basis to ensure the fund remains well aligned with your investment goals.