Like every investor, you too wish to grow wealth by investing in mutual funds. For this, you need to keep a track of your portfolio’s performance. It becomes an easy task when you have a strategy in hand. All you need to know are a few parameters to evaluate fund performance. Additionally, decide a frequency at which you will analyse the portfolio performance.
1. Compare fund performance based on horizon
While analysing the performance of a fund, you may take investment horizon into consideration. The longer you stay invested, the higher is the inflationary pressure and the risk involved in investment. Thus, the rate of return earned by a long term investor will be higher than that earned by a short-term investor. If you are a short-term investor, then you cannot expect liquid funds to yield double digit returns. But historically, equities have delivered average returns of around 12%. So, if the existing equity fund has been unable to match even the bare minimum performance, then you would have to make a move.
2. Look for higher alpha
Alpha implies the extra returns which the fund delivers over and above the benchmark. It reflects how effectively have the fund manager’s strategies performed. A good fund is one which is able to generate higher alpha. Alpha is given in the factsheet of the mutual fund. You can compare fund alpha with the benchmark to find out how much more returns are being generated. It also helps in justifying the annual fee which you are paying to the fund house to manage your portfolio. Ideally, you can expect the alpha to be more than the fund’s expense ratio. Suppose your fund’s expense ratio is 1.5 per cent, then the fund needs to produce alpha of more than 1.5 per cent. If it lags behind the said yardstick, then it’s time to look for better options.
3. Compare performance with target rate of return
As an investor, you need to have personal targets when it comes to assessing fund performance. It is because not every fund would be suitable for you. Moreover, with changing life stages and market conditions, it becomes very necessary to become contextual while measuring portfolio performance. Consider a fund which has been a top performer in its category and has outperformed the benchmark; say it delivered a return of 10% over a period of 7 years. However, your target rate of return was 12%. So, from this perspective, the fund has underperformed your expectations. You may think of switching to a better fund which is giving higher returns.
4. Compare funds based on rolling returns
In order to arrive at the right decision, you need to choose the right metric to measure fund performance. Consider a scenario wherein you and your friend have invested in the same equity fund. Your friend has made a one-time investment of Rs 10,000 whereas you have initiated a monthly SIP of Rs 10,000. As you know, the factsheet of a fund reflects annualised returns of the fund over a given time horizon. It is computed based on the beginning and end fund values and doesn’t consider the intermediate values. Annualised returns can very well reflect performance of one-time investment. However, to analyse SIP performance you need much more than annualised returns. For that, you may consider rolling returns which would accurately reflect how your fund value grew throughout the time horizon.
5. Keep an eye on expense ratio
Every fund house charges its investors a fee for managing their portfolio known as the expense ratio. It is charged on fund’s assets under management and plays a critical role in the quantum of returns that you may earn on mutual fund investments. Ideally, as the fund house grows bigger in size, it should be able to reduce its expense ratio owing to economies of scale. But if your fund’s expense ratio is increasing continuously, then seek reasons behind it. It might be the result of high level of trading activity going on to take advantage of the market conditions. However, if the increase in expenses is not being compensated by a corresponding increase in returns then it’s a red flag. The fund manager might be simply trading frequently to correct his bets which have gone wrong. In case this situation persists, you may better find an alternative instead of sticking to the fund.
Archit Gupta, is Founder & CEO of ClearTax. Views expressed are his own