What is Mutual Fund?

A mutual fund is a pool of money managed by a professional Fund Manager. It is a trust that collects money from several investors who share a common investment objective and invests the same in equities, bonds, money market instruments and/or other securities.

Is mutual fund a good idea?

Mutual funds are a good investment for investors looking to diversify their portfolios. Instead of going all-in on one company or industry, a mutual fund invests in different securities to try and minimize your portfolio’s risk.

What are the parameters you need to compare in mutual funds?

Product:

While comparing funds, the first aspect that you need to check if the product is suitable as per your risk profile. To do this you need to look at the product’s risk rating and compare it with your risk profile. For e.g., if you’re an investor with a moderate risk profile then a moderate risk hybrid fund aligns with your risk profile whereas a high risk mid/small-cap fund doesn’t. You need to first ensure that the shortlisted schemes suit your risk profile. Doing this at the start will help you compare the right mutual fund schemes.

You can check the scheme’s risk by checking the scheme’s riskometer.

Performance:

Although past performance does not guarantee future returns, evaluating performance on consistency parameter can help you narrow down your scheme list.

Examine the consistency of outperformance of funds as compared to its category and benchmark over different time frames, i.e., bullish, bearish and volatile periods. You can check the performance of the funds against its benchmark from the fund factsheet.

Checking the fund’s quartile ranking can also help to find a scheme that is consistent.

Quartile ranking which shows quarter on quarter fund’s performance among its peers is a good indicator. Mutual funds with the highest returns in the chosen time period are assigned top quartile, whereas those with the lowest returns are assigned bottom quartile.

Check if a fund has consistently figured in the top quartile for 4–6 quarters. It indicates that the fund is outperforming its peers.

While evaluating performance among the peer group, it is also important to know if the fund has taken the higher risk as compared to its peers to deliver performance. Sharpe ratio that highlights risk-adjusted returns of any scheme could be helpful in doing this.

Person:

The person managing the fund — the fund manager — plays a very important role in the performance of any mutual fund scheme. Fund managers come with their own style, expertise and skills. He’s like a captain of the ship who gives direction and drives the fund’s performance. Know who the fund manager is and his past track record. Check the performance of the funds he manages. An objective parameter to evaluate the fund manager’s performance is to check the Alpha of a fund.

Portfolio allocation:

Every fund has a different portfolio allocation strategy and objective. While comparing funds, one needs to know where and how much the fund invests in any asset/sector/stock to evaluate if the fund is adequately diversified. One should also look at the fund’s AUM. Everything else remaining constant, funds with higher AUM are less risky than funds with lower AUM.

The portfolio of the different funds is available on the monthly factsheet. The stocks, its percentage of total AUM and portfolio classification by asset allocation is also published on the factsheet.

Price:

Price or cost is another parameter by which we can compare mutual funds.

The Mutual Fund companies charge Asset Management fees or expense ratio for managing your investments. Different products have different expense ratio. It impacts the performance or returns provided by a fund as it factors in the expense ratio. With other parameters remaining same, you should choose fund with lower expense ratio.

While you need to also consider exit load levied on the scheme before you redeem. Generally, equity mutual funds levy exit loads of up to 1% for redemptions within 365 days from the date of purchase.

So, you are now ready to understand ‘what’ and ‘how to’ go about comparing mutual funds. However, if you are still in doubt, consult a financial advisor to build a right mutual fund portfolio for you.

What is NAV?

NAV stands for Net Asset Value. The performance of a mutual fund scheme is denoted by its NAV per unit.

Just like an equity share has a traded price, a mutual fund unit has Net Asset Value per Unit. The NAV is the combined market value of the shares, bonds and securities held by a fund on any day (as reduced by permitted expenses and charges). NAV per Unit represents the market value of all the Units in a mutual fund scheme on a given day, net of all expenses and liabilities plus income accrued, divided by the outstanding number of Units in the scheme.

TYPES OF MUTUAL FUND SCHEMES:

MUTUAL FUND SCHEME CLASSIFICATION

Mutual funds come in many varieties, designed to meet different investor goals. Mutual funds can be broadly classified based on –

Organization Structure — Open ended, Close ended, Interval

Management of Portfolio — Actively or Passively

Investment Objective — Growth, Income, Liquidity

Underlying Portfolio — Equity, Debt, Hybrid, Money market instruments, Multi Asset

Thematic / solution oriented — Tax saving, Retirement benefit, Child welfare, Arbitrage

Exchange Traded Funds

Overseas funds

Fund of funds

SCHEME CLASSIFICATION BY ORGANIZATION STRUCTURE

• Open-ended schemes are perpetual, and open for subscription and repurchase on a continuous basis on all business days at the current NAV.

• Close-ended schemes have a fixed maturity date. The units are issued at the time of the initial offer and redeemed only on maturity. The units of close-ended schemes are mandatorily listed to provide exit route before maturity and can be sold/traded on the stock exchanges.

• Interval schemes allow purchase and redemption during specified transaction periods (intervals). The transaction period has to be for a minimum of 2 days and there should be at least a 15-day gap between two transaction periods. The units of interval schemes are also mandatorily listed on the stock exchanges.

SCHEME CLASSIFICATION BY PORTFOLIO MANAGEMENT

Active Funds:

In an Active Fund, the Fund Manager is ‘Active’ in deciding whether to Buy, Hold, or Sell the underlying securities and in stock selection. Active funds adopt different strategies and styles to create and manage the portfolio.

The investment strategy and style are described upfront in the Scheme Information document (offer document)

Active funds expect to generate better returns (alpha) than the benchmark index.

The risk and return in the fund will depend upon the strategy adopted.

Active funds implement strategies to ‘select’ the stocks for the portfolio.

Passive Funds:

Passive Funds hold a portfolio that replicates a stated Index or Benchmark e.g. –

Index Funds:

Exchange Traded Funds (ETFs):

In a Passive Fund, the fund manager has a passive role, as the stock selection / Buy, Hold, Sell decision is driven by the Benchmark Index and the fund manager / dealer merely needs to replicate the same with minimal tracking error.

ACTIVE V/S PASSIVE FUNDS:

Active Fund –

Rely on professional fund managers who manage investments.

Aim to outperform Benchmark Index

Suited for investors who wish to take advantage of fund managers’ alpha generation potential.

Passive Funds –

Investment holdings mirror and closely track a benchmark index, e.g., Index Funds or Exchange Traded Funds (ETFs)

Suited for investors who want to allocate exactly as per market index.

Lower Expense ratio hence lower costs to investors and better liquidity

CLASSIFICATION BY INVESTMENT OBJECTIVES

Mutual funds offer products that cater to the different investment objectives of the investors such as –

Capital Appreciation (Growth)

Capital Preservation

Regular Income

Liquidity

Tax-Saving

Mutual funds also offer investment plans, such as Growth and Dividend options, to help tailor the investment to the investors’ needs.

GROWTH FUNDS:

Growth Funds are schemes that are designed to provide capital appreciation.

Primarily invest in growth-oriented assets, such as equity

Investment in growth-oriented funds require a medium to long-term investment horizon.

Historically, Equity as an asset class has outperformed most other kind of investments held over the long term. However, returns from Growth funds tend to be volatile over the short-term since the prices of the underlying equity shares may change.

Hence investors must be able to take volatility in the returns in the short-term.

INCOME FUNDS:

The objective of Income Funds is to provide regular and steady income to investors.

Income funds invest in fixed income securities such as Corporate Bonds, Debentures and Government securities.

The fund’s return is from the interest income earned on these investments as well as capital gains from any change in the value of the securities.

The fund will distribute the income provided the portfolio generates the required returns. There is no guarantee of income.

The returns will depend upon the tenor and credit quality of the securities held.

LIQUID / OVERNIGHT /MONEY MARKET MUTUAL FUNDS:

Liquid Schemes, Overnight Funds and Money market mutual fund are investment options for investors seeking liquidity and principal protection, with commensurate returns.

– The funds invest in money market instruments* with maturities not exceeding 91 days.

– The return from the funds will depend upon the short-term interest rate prevalent in the market.

These are ideal for investors who wish to park their surplus funds for short periods.

– Investors who use these funds for longer holding periods may be sacrificing better returns possible from products suitable for a longer holding period.

* Money Market Instruments includes commercial papers, commercial bills, treasury bills, Government securities having an unexpired maturity up to one year, call or notice money, certificate of deposit, usance bills, and any other like instruments as specified by the Reserve Bank of India from time to time.

CLASSIFICATION BY INVESTMENT PORTFOLIO

Mutual fund products can be classified based on their underlying portfolio composition

– The first level of categorization will be based on the asset class the fund invests in, such as equity / debt / money market instruments or gold.

– The second level of categorization is based on strategies and styles used to create the portfolio, such as, Income fund, Dynamic Bond Fund, Infrastructure fund, Large-cap/Mid-cap/Small-cap Equity fund, Value fund, etc.

– The portfolio composition flows out of the investment objectives of the scheme.