How to Analyze a Mutual Fund Before Investing: Key Points for New Investors

Investing in mutual funds can be a strategic way to grow your wealth, but it's crucial to approach this decision methodically. By evaluating various parameters, new investors can make informed choices and align their investments with their financial goals and risk tolerance. In this guide, we’ll walk through the key points to consider when analyzing mutual funds.

Key Parameters for Mutual Fund Analysis

When evaluating mutual funds, it's important to consider several critical parameters to ensure that you select a fund that is likely to perform well and matches your investment objectives and risk profile. Here are the key points and their respective ranges to look for:

1. Historical Performance

1-Year Return: Should be positive and ideally above the category average. 3-Year Return: Consistent annualized returns around or above the benchmark. 5-Year Return: Demonstrates long-term growth, ideally outperforming the benchmark.

2. Expense Ratio

Equity Funds: Typically below 2. Debt Funds: Typically below 1.

3. Fund Managers’ Track Record

Experience: Preferably more than 5 years of managing similar funds. Performance: Consistent returns compared to peers and benchmark.

4. Asset Under Management (AUM)

Equity Funds: Ideally between 500 crore to 5000 crore. Debt Funds: Ideally between 200 crore to 3000 crore.

5. Standard Deviation

Equity Funds: Typically between 15-20. Debt Funds: Typically below 5.

6. Sharpe Ratio

Equity Funds: Typically above 1. Debt Funds: Typically above 0.5.

7. Beta

Equity Funds: Typically between 0.8 and 1.2.

8. Portfolio Turnover Ratio

Indicates how frequently the portfolio is changed, lower ratios indicate a long-term approach. Idally below 50.

9. Expense Ratio

Equity Funds: Should be below 2. Debt Funds: Should be below 1.

10. Exit Load

Should be minimal or zero, especially if you plan to redeem units within a short period.

Avoid Relying Solely on Point-to-Point Returns

When evaluating mutual funds, always look beyond point-to-point returns, which can be misleading. To get a clearer picture of a fund's performance, utilize the concept of rolling returns. Rolling returns are based on a moving time frame and provide a more accurate assessment of consistency and predictability. This method allows you to see how a fund has performed over a range of market conditions, giving you a better understanding of risk and return.

Understanding Rolling Returns

Let's illustrate this concept with an example. Consider the Nippon India Large Cap Fund and the Aditya Birla Sun Life Frontline Equity Fund, both of which have delivered an average annual return of 14.9% over the past 10 years. By using rolling returns, you can determine how consistent this performance has been. For instance, if you want to invest for 5 years, instead of looking at a single 5-year period, you would look at how the funds would have performed over 5 years starting from any given day.

Here’s a simplified process to calculate rolling returns:

Calculate 5-year returns starting from any given day for both funds. Repeat the process for every subsequent day, creating a series of 5-year returns. Calculate the average, minimum, and maximum returns from this series. Use this data to compare the funds and see how consistently they have performed.

In the example provided, Aditya Birla Sun Life Frontline Equity Fund has delivered over 12% returns 63% of the time, while Nippon India Large Cap has done so 69% of the time. This indicates that Nippon India Large Cap has a slightly higher probability of delivering consistent returns over the long term.

Where to Find Rolling Returns Data

Rolling returns data for Indian mutual funds can be obtained from various sources. Paid subscriptions like Ace and Morningstar offer this data, but there are also free resources available. Websites like ET Money, Primeinvestor, and Advisorkhoj provide free access to rolling returns data for mutual funds.

Conclusion

In summary, analyzing mutual funds before investing involves several key parameters and the use of rolling returns. By examining historical performance, expense ratios, fund managers' track records, asset under management, standard deviation, Sharpe ratio, beta, and other metrics, new investors can make informed decisions. Additionally, using rolling returns helps assess the consistency and reliability of a fund's performance over time.

While there's no guarantee of future performance, relying on historical data and rolling returns can provide valuable insights into a fund's stability and predictability.