Choosing a good mutual fund is not easy

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For beginners, it is not easy to choose a mutual fund scheme to invest in. Even I have gone through this. I initially relied on the advice of my friends and / or family members, you have invested in mutual funds, gave. Then, I tried doing my own home work by reading relevant magazines to understand the intricacies of investing in fund schemes.

It took a long time before I was able to set a few rules for myself and these worked for me. It is a mix of several intrinsic and extrinsic factors.

Begin with understanding your needs as an investor. What is the purpose of investing and so for how long do you want to invest? How much risk can you take as the fund you choose will depend on that, and so will the returns you earn.

No scheme is good or bad in itself but understanding your needs can help you determine whether a scheme is suitable or not. For instance, I am a conservative investor. Hence, I am not comfortable with aggressive schemes, I prefer conservative ones. These may not give stellar returns, but do not swing sharply in volatile markets.

Ask yourself if you need returns on a regular basis or you can wait till maturity. Depending on that, opt for the dividend paying option or the growth options of a scheme.

Then, you also need to do your homework on fund houses, their track record and also their schemes' past performance, specially in case of equity schemes. When looking for an equity scheme, make sure you see the performance of the equity category of a fund house. It can give you an idea of a fund house's caliber to manage equity schemes.

There are a lot of complex risk return metrics that fund houses use, which will sometimes even overwhelm the most seasoned of investors. But, with experience, I now only rely on a few. Here are afew

Fund classifications

As a beginners if you are ready to take little risk and have age on your side, you portfolio should be dominated by equity diversified large cap funds. This is because large cap stocks are least risky and so is a fund investing in these funds. Mutual fund rating agency, Value Research considers stocks comprising the top 70 per cent of the market capitalisation large cap. Or, equity diversified fund as it invests in stocks from across sectors. Take for example, those who invested heavily in infrastructure funds, are ruing their investment decision today.

Fund diversification

I like to choose funds where the top 10 holdings do not exceed 4045 per cent of the portfolio. Also, I like fund managers who have the courage to purchase beaten down and under owned sectors. These sectors or stocks could have a higher possibility of outperforming the broader indices. And as a rule, I avoid sector funds.

Expense ratio

The expense ratio states how much you pay a fund in percentage terms every year to manage your money. Say you invest ~10,000 in a fund with an expense ratio of 1.5 per cent, then you pay ~150 to manage your money. That is, if a fund earns 10 per cent and has a 1.5 per cent expense ratio, it would mean an 8.5 per cent real return for you. I prefer schemes with an expense ratio is less than that of its category average. Though, I am not obsessed with choosing the one with the lowest ratio.

Risk and return

While long-term performance is important, I also look at comparative improvement in performance figures over periods of one year or less. Especially so, if the fund manager has changed recently. Also, I Deviation of returns is not over 20 per cent. This shows how much the fund returns have deviated from the mean level. The higher the value of standard deviation, the greater will be the volatility in the fund returns. For instance, if a fund's Standard deviation is 28 it means that the fund's return can fluctuate in either direction (up or down) by 28 per cent from its average return.

Benchmark

A benchmark is standard against which the performance of a fund is fund's performance with a more relevant one. For instance, I would prefer to compare a multi-cap fund (having 45 per cent large-cap stocks) with the CNX 500 index than the Nifty, even if the latter is its benchmark.

Portfolio characteristics

Being conservative, I prefer that my fund's composite price-to earnings ratio as well as price-to book ratio are either at a discount to that for the broad indices or at a premium of maximum 5-7 percent

Happy Investing!!

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