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How to Analyze Mutual Fund Performance

Without an evaluation, an exam is really just you jotting down your thoughts on various subjects.

Evaluations (and the promise of awesome grades!) give direction to examinations – they allow you to analyze your weaknesses and strengths and give you an insight into what you need to brush up on for next time. Analyzing a mutual fund’s performance is the same! It helps you (the investor) evaluate how your selected funds are performing, and make decisions accordingly to further your financial goals. 

Remember, checking the mutual fund performance of any investment you plan on making can be useful because –

  1. It will help you make informed financial decisions.
  2. It can potentially save you money in the form of fees and transactional costs.
  3. It can offer you insight into the risk and rewards while accounting for your risk capacity.

Today, we wanted to touch upon some important parameters that can help you check mutual fund performance. This is important to do, because it allows you to compare mutual fund performance before investing, and can also help you figure out your next steps after investing!

Here are the key parameters which we found were helpful in checking mutual fund performance – 

  1. Cost – There is a term called – expense ratio. The expense ratio refers to the percentage of your total invested assets, that are being paid off as fees involved throughout the process of investing, per annum. So if you are investing worth ₹20,000, and your fund manager is charging you an annual fee of ₹3,000, then the expense ratio is 15%. Typically, however, your expense ratio should be manageable; falling between the range of 0.5% to 1%. This is an important parameter for mutual fund performance because the cost is effectively eating into your returns, and it needs to be accounted for. 

Mutual funds that have lower expense ratios are more cost-efficient.

2. Risk – While risk and returns are two sides of the double-edged sword that is investing – the capacity for risk varies from investor to investor. Whatever your risk appetite might be – identifying it (low, moderate, high) is an important parameter for mutual fund performance because it has a direct impact on your returns. You can assess risk by examining the volatility of a mutual fund. This can be measured using standard deviation (a percentage that shows how much the returns of a mutual fund scheme are likely to fluctuate with respect to its recorded average annual returns). A higher percentage of standard deviation denotes a more volatile mutual fund; one with higher risk.

Mutual funds with lower susceptibility to market fluctuations are a safer option for investors who have not yet determined their risk tolerance.

3. Fund Vs. Benchmark –  A benchmark is an index that is used to measure the overall mutual fund performance. Let us assume that you have invested in the mutual fund option that is right for you, and you earn 15% returns within one year of investing. But, during that same time, the benchmark for your mutual fund was giving 18% returns. Here, your benchmark outperformed your selected fund option. This is an important parameter of mutual fund performance analysis as it gives investors a clear indicator of possible returns for any given mutual fund.

Mutual funds with returns that are equal to or better than the benchmark are a safe option to start with.

4. Consistency – It’s good when a mutual fund’s performance is good. But, it’s great when a mutual fund’s performance is good consistently. Look for consistency in the mutual fund’s performance over multiple time periods. Analyze its returns across various market cycles, including both bullish and bearish phases. Consider whether the selected mutual fund consistently outperforms its benchmark or has shown intermittent periods of falling short of its benchmark. This is an important parameter of mutual fund performance, and you can typically look back over 5-10 years to check a fund’s consistency.

Mutual funds that are consistently performing well, are good options as compared to those giving good returns once in a blue moon.

5. Fund Managers – Many investors these days are using investment apps. But the role of fund managers is not redundant. Fund managers can be resourceful and helpful sources of information and guidance with respect to investing. So, if you do opt to invest in mutual funds through a fund manager, it is prudent to check the past performance of said manager as well. Consider the manager’s tenure, investment philosophy, and ability to generate consistent returns over time – all these things can potentially have an impact on your mutual fund performance, and your investment portfolio by extension.

The fund manager with a sound track record of past investments is your new best friend!

6. Portfolio Turnover Ratio – How many times is a fund manager trading securities in your portfolio? A high number of transactions indicates a higher portfolio turnover ratio and can mean higher fees and transactional charges. Portfolio Turnover Ratio (PTR) is an important tool for mutual fund performance analysis, and it can be influenced by the individual decision-making of a fund manager, market conditions, and the overall investment strategy as well. It is important to note that sometimes even a high PTR can be advantageous, but only if you see your returns growing significantly over time in spite of the high PTR.

Cost-effective mutual funds which have a relatively lower Portfolio Turnover Ratio are a safer option for investors.

7. Risk-Adjusted Returns – In addition to checking the past performance of mutual funds, some investors also find it helpful to check for risk-adjusted returns. This means considering how much risk needs to be taken – and to achieve what volume of returns. One commonly used measure for risk-adjusted returns is the Sharpe ratio, which considers the excess return generated per unit of risk (measured by standard deviation). This is ultimately an important measure of mutual fund performance because it can help investors decide whether or not the risk of investing in a particular mutual fund is worth it or not!

Mutual funds with a higher Sharpe ratio have a higher risk-adjusted return.

And there you have seven key parameters that can shed some light on how to check a mutual fund’s performance. It is not necessary that all parameters will work in your favor at all times. But, the key is to find the combination of parameters that are positive and also align with your financial goals.

FAQs

  • Why do I need to analyze the performance of mutual funds?

Analyzing the performance of mutual funds can help you make informed financial decisions, and potentially save you money in the form of fees and transactional costs. Such a performance analysis is also necessary as it can offer you insight into the risk and rewards while accounting for your risk capacity.

  • What is Portfolio Turnover Ratio?

Portfolio Turnover Ratio is the measure of how quickly units of a fund are bought or sold by the fund’s managers, over a given period of time.

  • What are risk-adjusted returns?

Some investors find it helpful to check for risk-adjusted returns. This means considering how much risk needs to be taken, and to achieve what volume of returns. 

  • What is the Sharpe Ratio?

The Sharpe ratio is a commonly used measure for risk-adjusted returns that considers the excess return generated per unit of risk (measured by standard deviation). A higher Sharpe ratio denotes a higher scope for risk-adjusted returns.

  • What is a mutual fund benchmark index?

A benchmark index for a particular mutual fund scheme is defined as the index against which the scheme intends to measure its performance.

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