Mutual fund companies in India are managing an estimated Rs.27 trillion worth of funds as of the year 2020. Yet the mutual fund penetration in India is amongst the lowest of all major economies. So the scope of growth is massive and because of this reason, more and more funds are continuously emerging in the Indian mutual funds space.
Today there are over 3000 mutual fund schemes for an investor to choose from. Here I am unable to pick a restaurant to eat from due to the sheer variety one can find on the Swiggy App. So selecting the right mutual fund scheme would be quite a daunting task. Along with that, there is an onslaught of agents and so called advisors who are employed by the fund houses with the sole purpose of luring retail investors to invest in their fund.
There is no doubt that largely mutual funds have underperformed their benchmark indices over the last 5 years. But there are some really good performing funds as well, so selecting the right fund is nothing short of a million dollar solution. This is because no one can predict what the future holds. All one can do is the right research and make a choice by not falling into a trap of sales persons and fake advisors.
So here are a few things to keep in mind before investing in any mutual fund scheme:
1. Identify your own Goals and Risk Profile
Mutual Funds are categorized based on their asset allocation and risk levels. Equity mutual funds are considered to be of higher risk than Debt and Hybrid funds but come with the advantage of higher returns.
So before you make an investment, you need to assess your financial goals and the amount of risk you are willing to take for it. Your goals are basically your expected returns and the time period within which you want those returns. The higher your expectations, the higher risk you will have of losing your capital.
Identifying your investor philosophy (whether aggressive or conservative) will help you to narrow down your research to only a select few fund categories.
2. Returns consistency over different market cycles ( Bull run / bear market )
This is where we measure a fund’s past performance with a hope for a repeat of the same to occur in the future. Instead of just seeing what the returns of the funds have been over a 3, 5 and 10 year period, one should carefully examine the returns during various market cycles.
For instance, during a bull market most funds will provide good returns. The key is to identify funds which have outperformed their respective benchmark index. Similarly, you should not discount funds which have given negative returns during a bear market cycle. Instead, look for funds which have performed better than the overall markets during uncertain time periods.
3. Watch out for the Expense Ratios
Mutual funds are run by an expert team of analysts and professionals. So running a mutual fund is an expensive ordeal and all the costs in the end will have to be borne by the customers. These costs are charged to us in the form of commissions and is known as a fund’s Expense Ratio.
The expense ratio can make or break your investment. So before investing in mutual funds you should thoroughly understand all the costs and fees charged by the fund house. If two funds from the same category have an expense ratio of 1% and 2% respectively, the latter will need to outperform the former by 1% annually to meet the same returns. Over a long term investment horizon, this 1% difference can have a significant impact on your returns.
4. Look for the fund’s Ratings and Management
Many rating agencies such as CRISIL and Valueresearch.com rate mutual fund schemes after conducting a solid research which is done by experts. You can look out for funds which have been rated highly by such companies.
You should alternatively do your own research as well. In the age of the internet, it should not be too hard for you to find information online. You should look for funds which are managed by an experienced team of individuals with a track record of decent returns. One way to judge a fund manager would be to see his performance during market uncertainty. A bonus would be to find funds where the managers have invested a portion of their capital in the fund too. Meanwhile funds with no previous record of their manager’s performance should be avoided.
5. Don’t restrict yourself to only funds with a high AUM
Don’t restrict yourself to funds with a high asset under management and that are being run by famous brands such as SBI and HDFC. Sure a SBI or a HDFC fund may have had lucrative returns in the past and even may do in the future. But during your research be open to the not so popular ones as well.
Nowadays, there are many funds which are being offered by small firms and portfolio managers. They too have a very experienced team and must not be ignored. Some funds even have a portion of their corpus invested in international stocks, adding a layer of global diversification to your portfolio.
But if you go with such funds, be sure to check the SEBI website and check for their SEBI registration. Only invest in funds that are registered and follow the rules and guidelines set by the government of India.