Knowing what to expect in terms of performance helps

As investors, all of us expect good performance from our investments.

However, ascertaining whether it is actually happening or not can be tricky. More, it is essential to put performance in proper perspective to get the true picture.

“Good performance” is a subjective thing. Ideally, to analyse performance, one should consider returns and the risk taken to achieve these. Consistency in performance over time, as well as portfolio selection, are other factors that should play an important part in this process. Therefore, if an investment in a mutual fund scheme takes you past your risk tolerance while providing you decent returns, it cannot always be termed as good performance. In fact, at times, to ensure your investment remains within the parameters defined in the investment plan, it may be wise to exit from that scheme.

 

In other words, you need to address the question as to how much risk did the fund manger subject you to, and if he gave you an adequate reward for taking that risk. You also need to consider whether your own risk profile allows you to accept the revised level of risk.

Consistency in performance is another key element. ‘Beta’ is the measure of the relative volatility of a mutual fund scheme. It indicates how much the fund will rise or fall in relation to changes in its benchmark index. If the fund has a beta of 0.90, it represents that the fund has gone up (or down) by a factor of 0.90 for every one per cent change in the benchmark index. Simply put, a beta of less than 1 indicates lower highs and higher lows than the benchmark index.

Using beta can help you in matching your risk tolerance to the appropriate mutual funds. In other words, beta measurements can help you in making a sound decision, as well as ascertain what will suit your profile.

Measuring performance properly is another key component of this process. Many mutual fund investors are not sure how to measure the performance of their investments. Invariably, they consider either dividend or change in the net asset value for measuring performance. This method, obviously, does not give them a true picture. Total return is the best way to measure it.

Total return is the sum of two components — dividend and capital appreciation. In other words, total return is the sum of what your investment earns over a period of time. While assessing total returns, some important issues need to be taken into account.

For example, total return can be presented either on a cumulative basis or as an average annual compounded rate. However, it is not advisable to rely solely on cumulative return, as it does not reflect the true picture. For example, a fund with 10 years cumulative return of 150 per cent may not have given an average annual compounded return of 15 per cent.

It is also important not to rely on short-term performance to make a decision. In fact, many investors do so even for investments made through a systematic investment plan. You must remember that a disciplined approach is the key to success for equity investing and it works well only when one follows this process for a longer period, say, five-seven years or even more. A long-term approach also ensures you get the best out of the “power of compounding”. Therefore, once you start the process, continue it irrespective of the market condition.

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The writer is CEO, Wiseinvest Advisors