With 37 funds in play, what are the criteria that should guide investors while selecting a Mutual Fund
ALL Asset Management Companies (AMCs) comprise eminent board of trustees and are well regulated. We would take a holistic view on the AMC and not merely look at its size before recommending it to clients.
With a mere 5% of Indian household savings going to mutual funds, compared with more than 60% worldwide, there is a lot of headroom for mutual funds to grow.
The potential, coupled with low-entry barriers, have resulted in as many as 37 AMCs doing business in India with a few more likely to join soon. The increased competition is putting pressure on the margins of AMCs. So what are the factors that an investor should keep in mind while choosing a fund?
Investment process
Disciplined approach in investments over a longer period of time plays a crucial role when we choose a fund. The AMC should have a well-defined investment process. The investment decisions of the fund house should not depend on an individual fund manager's whims and fancies. The investment universe of the stocks and securities should be a function of the pre-defined investment process. How much money they make or lose for you is not a function of their size but, rather, a function of how well a manager can select a portfolio of stocks for the long term, without taking any wild risks.
Management credentials
It is important to take a look at the past record of the promoter. Are they building business to sell it when a suitable opportunity arises or are they going to run the business? If they are building a business to sell it off, chances are they will look to grow the AUM at a very fast pace. It is important to look at fund managers' past track record. Fund managers are important when it comes to consistency in the fund management style. The experience and wealth of knowledge they bring helps to a great extent in the investment process. Analytical backbone offered by analysts is also important. There is nothing to worry if you come across a small fund house that has managed to retain fund managers for a long period of time. If you come across a change of guard rather often, beware.
Scale economics
Some small funds end up charging higher percentage of charges, typically nearing the maximum allowed limit of 2.5%. Put simply, if one invests Rs 100,000 in such a fund, you end up paying Rs 2,500 whereas in a fund with lower charges of say 2%, you will end up paying Rs 2,000 per year.
Small is volatile
Small funds may show spectacular returns as they can take meaningful exposure in small and mid-cap stocks. A Rs 50-crore fund can park Rs 2.5 crore or 5% of the fund assets in a Rs 200-crore market cap company. But a Rs 5,000-crore fund will not find it interesting, because even if it accumulates 10% shares in the company (Rs 20 crore), it may not form a meaningful part of the portfolio.
Typically, small funds, when they perform well, tend to attract money and grow large. But when they grow big, their performance tapers off, as they have to change the asset mix in favour of large-cap well-researched stocks that may not offer super-normal gains. Here the returns may not be the same as offered in the past. Investors in many cases are not able to digest this.
Investment mandate
Many small-sized funds may bypass their investment mandate or the investment objective in the short term as they do not appear in most of the analysts' radar. So for an investor, it is crucial to take a close look at the investment portfolio in light of investment objective of the fund.
If you invest in a small AMC and it is taken over, you are given an opportunity to exit at no exit loads. This opportunity should be exercised by investors in case they are not comfortable with the new management.
