A mutual fund is a professionally-managed form of collective investments that pools money from many investors and invests it in stocks, bonds, short-term money market instruments, and/or other securities. In a mutual fund, the fund manager who is also known as the portfolio manager, trades the fund's underlying securities, realizing capital gains or losses, and collects the dividend or interest income. The investment proceeds are then passed along to the individual investors. The value of a unit of the mutual fund, known as the net asset value per share (NAV), is calculated daily based on the total value of the fund divided by the number of units currently issued and outstanding.
All recomendations are made after applying a scientifically proven and well accepted methodology which assigns weightages to various parameters like:
Objective of the fund
Age of the fund
Timing of the fund
Portfolio turnover ratio
Risk adjusted returns
Downside risk probability
Which kind of scheme should you opt for: active or passive? Between the two, the passive types offer lesser rewards, in proportion with lower risk. The active types offer the lure of better rewards, but they also run a greater risk of falling flat. Over long period of times, indices are a fair reflection of the performance of an asset class or investment exposure.
The total money available with a scheme, at any point in time, is referred to as ‘Corpus’ or ‘Asset under management’. The mutual fund, on your and other investor’s behalf, invests this corpus in various securities, in line with its stated objectives. The corpus also shows the kind of faith reposed by the investors in the scheme. Reliance Mutual Fund, for example, was able to garner $1b in Reliance Equity Fund, which is ample testimony to its brand value and the level of trust shown by the investors in the Fund House.
Objective of the fund:
If your scheme strays from its chosen path, it could jeopardize your goals. Your fund manager might be doing so to generate more returns for you, but this change in strategy might not suit you. The best representation of a scheme’s objective is its asset mix and portfolios. Fact-sheets and reports illustrate each scheme’s portfolio break-up through a pie chart. Look at the graph of your scheme to make sure it is serving your objective. Look for deviations - for instance, an IT fund dabbling in other sectors, an income fund investing in stocks. This is your first cue that your scheme is straying from its mandate. A great financial disaster happened in the history of the Indian mutual funds market when US-64 deviated from its objective of maintaining an appropriate asset mix.
Age of the fund:
It means the total time since when the fund was launched. One ought to look at the track record of the funds very carefully. Most of the old AMCs always highlight the age of their fund. The age of the fund demonstrate the consistency of returns over the long term.
Timing of the fund:
It is easy to say with the benefit of hindsight that one should have bought at this low and sold at that high, and so on. But, in real time where your money is locked into a market that’s ticking, thoughts can easily get clouded by sentiment. It implies whether the time at which the money is being invested is right or not.
A measure of what it costs an investment company to operate a mutual fund. The expense ratio is determined through an annual calculation, wherein a fund's operating expenses are divided by the average rupee value of its assets under management. Operating expenses are taken out of a fund's assets and lower the return to a fund's investors.
Also know as "management expense ratio" (MER). The higher the expense ratio, the lower the net returns in the hand of the clients. One should select a fund with a lower expense ratio. SEBI has stipulated the upper limits for different categories of schemes.
All mutual funds trade securities regularly - some more regularly than others. A fund’s portfolio turnover rate reveals how much buying and selling is going on. The range can be enormous, with some funds turning over more than 100% annually. In general, high turnovers mean higher transaction expenses. That means the fund needs higher returns to offset the cost. It also reflects the passive /aggressive strategy of the fund manager.
If you are invested in an income fund, check the credit rating of the corporate paper held by it. This information is tabulated alongside the portfolio holdings in fact sheets and reports. The greater percentage of its portfolio in high – rated paper (rating of AA & AAA for bonds, and P1 & P2 for commercial papers) the safer is your investment. Typically, an income fund that stands for high safety should hold at least 90% in high rated instruments.
In equity funds, there are no such alphabetical symbols to tell you if your scheme is going in the right direction. An equity fund portfolio derives its strength from the quality of stocks held. We also look at the percentage of exposure to the unlisted companies. The lower is the exposure, the better the fund is. Be wary of its taking on a significant, and growing, exposure to dud and dubious companies.
The person(s) responsible for implementing a fund's investing strategy and managing its portfolio. A fund can be managed by one person, by two people as co-managers and by a team of three or more people. We look at the experience of the fund manager while selecting the scheme. If the fund manger has gone through various phases of the cycle then his decisions are wiser and get reflected in the performance of the fund.
Risk adjusted returns:
It is the risk adjusted ratio. the ratio describes how much excess return you are receiving for the extra volatility that you endure for holding a riskier asset. Remember, you always need to be properly compensated for the additional risk you take for not holding a risk-free asset.
A ratio that measures returns earned in excess of that which could have been earned on a riskless investment per each unit of market risk.
A measure of portfolio management's performance against risk and return relative to a benchmark or alternative measure. It is a straightforward way to evaluate the return a fund manager achieves, given the risk they take on.
The Sortino ratio is the same as the Sharpe ratio except that the risk is only measured with down moves (relative to some target value).
Downside risk probability:
The calculation of downside risk depends on where the downside return begins: less than the market rate, less than the risk-free rate, or less than zero. Implied volatility is used as a forward-looking measure of downside risk.
A divergence between the price behavior of a position or a portfolio and the price behavior of a benchmark.This is often in the context of a hedge or mutual fund that did not work as effectively as intended, creating an unexpected proit or loss instead.
Tracking errors are reported as a "standard deviation percentage" difference.This measure reports the difference between the return you received and that of the benchmark you were trying to imitate.