Mutual funds have been increasingly becoming a preferred choice of investment among investors owing to better liquidity, better risk management, better returns, and diversified portfolio. However, identifying the right fund for investment remains a daunting task for investors, particularly retail investors.
Keeping this mind, we are here for top mutual funds to invest, where we seek to educate our readers on how to scout in it.
There are different type of mutual fund in India. Hence, selecting a mutual fund is a two-step process where the first involves finalizing the fund category based on objective, risk appetite, and investment horizon, and the second involves filtering the funds from the said categories.
Let us see the first factors initially –
Objectives of investment in Mutual Funds
This refers to an individual goal that is personal to him/her. It could be anything right from buying an iPhone 11 Pro to purchasing a yacht or saving for children’s education and even retirement.
It refers to the time an investor has to fulfil the objective. The horizon can be as small as one day to as long as 25-30 years.
Based on the time horizon, there are specific categories of fund that should be used by investors to invest –
|< 1 Year||Liquid Fund|
|1-3 years||Debt Funds or Balanced Funds(If the investor wants to take a little extra risk)|
|3-5 years||Hybrid Funds|
|> 5 years||Equity Funds|
Note: You may opt for equity and other categories of funds for duration that doesn’t match with the above table depending on the riskSource: Tarrakki Research
Risks Involved in Mutual Funds refer to the degree of volatility an investor can withhold. In 2015, the Securities and Exchange Board of India mandated the fund houses to display a risk meter consisting of the five levels of risk associated with the fund. The standards defined are – low, moderately low, moderate, moderately high, and high.
The table below gives you the fund categories that are most suitable to different risk levels and time horizons.
|< 1 Year||1-3 years||3-5 years||> 5 years|
|Low Risk||Debt: Liquid||Debt: Short-term||Debt: Long-term||Hybrid: Balanced|
|Debt: Ultra Short-term|
|Medium Risk||Debt: Short-term||Debt: Long-term||Hybrid: Balanced||Equity: Large Cap|
|Hybrid: Balanced||Equity: Large Cap||Equity: Multicap|
|High Risk||Hybrid: Balanced||Equity: Large Cap||Equity: Mid Cap||Equity: Mid Cap|
|Equity: Index||Equity: Small Cap||Equity: Small Cap|
|Equity: Sector||Equity: Sector||Equity: International|
Factors for Choosing the Mutual Fund Scheme
Once the mutual funds’ category is selected based on the investment objective, time horizon, and risk appetite, you must choose a fund from the category. For choosing a mutual fund scheme, several parameters must be looked at. Following are some of the parameters that you may refer to while selecting a fund –
Relative Performance or the Alpha
Instead of absolute returns, you must compare from a comparative angle concerning its benchmark. The alpha generated by the fund is more important than the absolute returns. As active investors,we want to outperform the benchmark irrespective of the absolute figures.The regulator has now made the funds must use the Total Returns Index (TRI) as benchmarks. This is arrived at by taking into consideration the dividend component (if announced) by the companies in the index and is the actual measurements for the returns in the hands of an investor.
Relative performance to category
Every fund belongs to a category, and thus we must compare the funds to its peer group. For this, we should refer to the relative performance against the group or the category average. This comparison helps the investor get a holistic understanding of the fund’s performance.
A good fund is one who manages to score consistently. For example, a good batsman is one who scores in every match. If not a century, a decent above average score in every match is expected from a good batsman. Similarly, a good fund should ideally offer consistent returns year after year after year.
A fund that can generate alpha in both bull and the bear market is the ideal fund. The amount of returns may not, but consistency in a pattern is essential here.
Sound and stable management
Investors invest in management and not the numbers. Similarly, while choosing a fund, an investor should assess the profile of the fund manager, experience, qualification, past track record, the number of funds managed by him, and the likes. You may also want to understand the objectives of investment management and investment philosophy of the fund manager.
The expense ratio of a fund is the fees that are incurred towards managing the fund. The charges are auto deducted from the returns before giving back the profits to the investors.
All expenses incurred in the running of the fund, such as management fees, brokerage, research, custodian, subscription, printing, etc. are included in this figure. The regulator SEBI has capped the number at 2.25%. Also, direct plans have lower expense ratio due to the absence of distribution charges of the middle-man. Thus, you should invest in direct plans for better returns.
Check out the Tarrakki – best mutual fund app that offers investor direct plans of all the fund houses for free through one app.
Portfolio concentration is essential to see from a portfolio characteristics angle. Ideally, a Fund should not hold more than 50% of its assets in the top 10 names. Also, sectorally, a fund should not be very concentrated. This helps in offering diversification benefits to the investor.
It is worth reading the portfolio characteristics to that of objectives of investment and philosophy in the prospectus.
In terms of risk, an investor may look at metrics such as standard deviation. For equity funds, an investor should scout for the funds that have beta closer to 1 so that the fund does not get carried away in the up or the down market, and the returns are truly a reflection of the stock selection and not allocation.
Lastly, you should pay heed to parameters such as Sharpe ratio, and Sortino that provides you with an assessment on how much additional returns you may fetch if the risk is increased by a unit.
Should you need any other information about how to begin investing, feel free to reach out to us at email@example.com, and we could catch up for a cup of coffee. For more such engaging reads, feel free to subscribe to our blog. Alternatively, you can join our Facebook Group after signing up on the app available on iOS and Android for more knowledge related posts.