If you’re already a mutual fund investor or thinking about getting started, you’ll want to make sure your money is working as hard for you as it possibly can. After all, investing is not just about choosing the right funds, but also about tracking their performance to make sure they’re on course to meet your financial goals. So what kind of variables should you be mindful of when you track mutual fund performance, and what tools can you leverage for proper mutual funds analysis? Let’s find out!
Importance of Tracking Mutual Fund Performance
Whether you’re looking to invest in a new mutual fund scheme or just stay on top of your own portfolio, the importance of mutual fund performance analysis cannot be overstated. This practice helps you achieve the following:
1. It helps you make better decisions
Investors often fall into the trap of letting emotions dictate their decisions. Relying on ‘gut feelings‘ or misguided advice from friends and relatives rarely leads to success. Analysis should be backed by data and logical reasoning. That way, decisions can be more informed and rational.
For example, when you’re considering investing in a new scheme, understand how consistent it has been over the last 5 or 7 years instead of getting caught in the hype of high returns in the previous year. Similarly, when you’re tracking your existing investment and find that it’s been consistently lagging behind other funds of the same type, you can consider switching to a better fund.
2. It makes risk management easier
Mutual funds are heavily impacted by market forces, so when analysing a fund it’s important to not just focus on returns but the risks as well. Every investor has a certain risk tolerance and going above or below this threshold is sub-optimal. By analysing risk-adjusted returns with metrics like standard deviation, beta, and the Sharpe ratio, they can identify whether the fund’s risk profile aligns with their comfort level.
3. It allows you to spot underperforming funds
There are over 40 AMCs in India, collectively offering thousands of mutual fund schemes to investors. To find the best-performing ones, you must first filter out the underperformers. This can be done by comparing schemes with their benchmarks and category averages. You can apply the same logic to your own portfolio and analyse metrics such as CAGR, alpha, and NAV trends to decide whether or not your funds justify their place in your portfolio.
4. It ensures that the fund’s objectives are still aligned with your financial goals
When you first invest in a mutual fund, you ensure that its goals align with your own. However, this can change over time as your financial goals evolve. For example, if you invest in a small-cap fund to achieve a long-term goal, you’d ideally want to shift to a less volatile fund as you get closer to it.
Key Metrics for Mutual Fund Performance Analysis
A thorough mutual funds analysis is conducted by considering both qualitative and quantitative aspects of a fund. Qualitative assessment includes understanding the underlying factors that influence the fund’s performance, such as the fund manager, size of the team, AMC’s reputation and investment strategy, risk management approach, and so on.
For example, if a well-regarded manager leaves a fund, it may set off some alarms. However, if the AMC’s investment philosophy, structure, and risk management techniques are strong and consistent, the impact of the manager’s departure can be mitigated. Such factors cannot be measured but are essential as they give us a peek into a fund’s stability and future performance.
Quantitative assessment, on the other hand, is done using data to evaluate the fund’s performance and associated risk factors. Here are some of such key factors you should use in mutual fund performance analysis:
1. Benchmark Comparison (Alpha)
The aim of active management is to beat benchmark returns. When you’re investing in say, an equity fund, you’re hoping the fund manager will help you earn returns higher than the Nifty 50 benchmark. This is done through a metric known as alpha, which is the difference between a fund’s actual returns and the returns of the relevant benchmark. Alpha is adjusted for risk to give you a more accurate picture of the fund’s performance. If the alpha is positive, it reveals that the fund has outperformed its benchmark after adjusting for risk.
2. Historical Returns
You should always review a fund’s performance over a period of time, like 3, 5, or 7 years. This is because a longer time frame paints a clearer picture of the fund’s consistency, risk-adjusted returns, and how well the manager tackled different market conditions. One popular metric preferred by many investors is the CAGR. This gives you an average annual growth rate of an investment over a specific time period, but it’s important to note that CAGR on its own is not enough to assess performance as it doesn’t tell you anything about a fund’s consistency.
Two funds can have the same CAGR yet vary greatly in the consistency of returns. One could have steady returns, while the other may have very sharp highs and lows. Rolling returns are often used as a measure of a fund’s consistency.
3. Risk-adjusted Returns
Risk-adjusted returns help you measure whether your investment is delivering good returns for the level of risk involved, so you can use these to understand if your investment is worth the risk compared to other options. Here are some commonly used risk-adjusted returns:
1. Standard Deviation
This metric measures how much a fund’s returns vary from its average return, which is basically the fund’s volatility. If it’s bumpy, it means the returns are more volatile, whereas a smoother or lower standard deviation implies that the fund is stable.
2. Beta
The beta of a fund tells you whether an investment is more or less volatile than the market. If the beta is 1, the fund is returning in line with the market. A beta greater than 1 suggests that the fund is more volatile than the market, and a beta lower than 1 means the fund is not very volatile and is less likely to experience big swings in price compared to the overall market.
3. Sharpe Ratio
One of the most commonly used risk-adjusted metrics, the Sharpe ratio shows how well the fund is performing compared to the risk it’s taking on. The higher the Sharpe ratio, the better, as it means the fund is performing well considering the risk. Similarly, a lower ratio means that you’re earning lower returns for the same amount of risk taken.
There are other risk-adjusted returns as well, such as the Sortino ratio and Treynor Ratio. Each has a different formula and a different way of assessing risks and returns. These ratios can’t tell you anything on their own – they must be compared to other funds or benchmarks.
4. Expense Ratio
To manage your mutual fund investments, AMCs charge you a fee called the expense ratio, which covers the scheme’s administrative and operating costs. This fee is expressed as a percentage of the fund’s AUM. The lower the expense ratio, the higher your returns are, but this metric on its own shouldn’t stop you from investing in a fund that matches well your financial goals and risk tolerance. Funds that charge higher expense ratios often do so because their performance justifies the fee.
5. Portfolio Turnover
The portfolio turnover ratio tells us about the frequency with which a mutual fund buys and sells the assets within its portfolio. A high ratio means that the manager has adopted an aggressive style and has frequently bought and sold assets to rebalance the portfolio or to capitalise on new opportunities. The thing is, if a portfolio is churned too much, it can lead to higher transaction costs, which ultimately eat into the fund’s returns. But trading this actively can also allow the fund to capitalise on short-term opportunities or respond quickly to market changes, which can give returns a boost.
6. Portfolio Overlap
Portfolio overlap refers to the amount of securities that are common between different funds within your portfolio. One of the biggest selling points of mutual funds is the built-in diversification they offer. You may hold multiple funds in your portfolio and think that you’re well-diversified, but if these funds have significant overlap in their holdings, you may actually be diluting the effect of diversification unknowingly. For example, if you have equity funds in your portfolio that hold large portions of Reliance Industries, you become extra reliant on the performance of Reliance.
Remember that when you’re comparing funds, you should only consider funds within the same category. This is important because different mutual fund categories have different risk profiles, investment strategies, and expected returns. For example, you can’t judge the returns of a large-cap fund by comparing it to a small-cap fund, as small-cap funds have much higher volatility, growth potential, and the universe of stocks they select from is different. Large-cap funds focus on established blue-chip companies, while small-cap funds invest in smaller, high-risk, high-potential companies.
How to Track Mutual Fund Performance Analysis
You can track mutual fund performance in a variety of ways:
1. Using phone apps
You can use the AMCs website to get the relevant data, but many apps and platforms allow you to track mutual fund performance in real time.
2. Mutual fund fact sheet
Fact sheets are released by AMCs regularly and they contain all the essential information about a particular mutual fund. They include performance-related data, risk-adjusted returns, portfolio composition, AUM, fund manager details, riskometers, and much more to help you conduct mutual fund performance analysis. You can easily download them from AMC’s website.
3. Portfolio trackers
These tools let you manage all your mutual fund investments in one place. They provide you with all the necessary data and can also be used to check the level of portfolio overlap.
4. Financial advisors
While these online tools are great for tracking performance, they lack the personalised touch and expert insights that a professional financial advisor can give you. The platforms don’t take into account your unique financial situation, risk tolerance, or goals. A financial advisor does and offers advice and guidance tailored to you. They can also help you monitor your investment, make necessary adjustments, and hold regular portfolio reviews to keep you on track.
Conclusion
To perform a thorough mutual funds analysis you need to consider two things – the qualitative aspects of the fund which include understanding the fund manager’s expertise, the AMC’s reputation, the investment philosophy, and the fund’s risk management strategies, and quantitative aspects which cover metrics like returns, Sharpe Ratio, portfolio turnover, expense ratio, and alpha.
The factors we discussed in this article focus mainly on the mutual fund itself, but it’s important to be mindful of your own financial situation, goals, and risk tolerance when investing. When you’re analysing a fund’s metrics, don’t just look at its performance but also at how well it fits with your risk appetite and goals. Similarly, if you’re tracking your own portfolio, check whether the fund’s objectives are still aligned with your profile. Over time, your financial priorities will change, so it’s important to make sure that your investments continue to work toward what you want to achieve in the future.
