Before investing in an equity mutual fund,
it would be better if investors take a hard look at the following four
parameters:
1. SUSTAINABLE PERFORMANCE: It is always safe and better to choose a fund
which has a well-established track record of at least three to five year
period. The comparison of over a longer period gives the investor a better
perspective with regard to the ability of the fund to ride any bear phase
in the stock markets.
Several funds do well in certain time periods and
fail miserably in other time periods. For example, HDFC Capital Builder was
doing well till 2005. But in the last six months, its performance had
dropped and the fund is an underperformer of late. Its present rank, on a
one-year scale, is 120 out of a total of 135 diversified equity funds
(source: Mutual Fund Insight).
In contrast, HDFC Top 200 has given
superior performance in bear phases as well as bull runs since its launch
in 1996. In addition, one needs to compare the fund’s performance with the
benchmark index. Every fund would have a yardstick, called benchmark
index, against which it requires to be measured.
BSE Sensex is the
benchmark index for Tata Select Equity Fund, Templeton India Growth Fund,
DSPML Opportunities Fund. Funds, like, Tata Index Fund, Sundaram Select
Focus and Reliance Growth are benchmarked to S&P CNX Nifty.
One also
needs to use the performance
comparison with funds of similar objective. For example, Birla Sun Life
Equity fund is a large-cap oriented one and the major portion of total
assets is in large-cap stocks.
The fund’s performance is to be compared
with other funds, that have large-cap orientation, like, Tata Pure Equity,
Principal Growth, etc. Likewise, Birla Mid-cap, a Mid-cap oriented fund is
required to be evaluated in relation to other Mid-cap funds, like, Franklin
India Prima, Magnum Global, etc
2. SUITABILITY: Almost all investments have a certain degree of risk attached to
them. Risk appetite differs from person to person. In general, the degree
of return is in consonance with the amount of risk taken, provided the
investment is well managed by the investment manager.
Some funds take
higher risk than other funds. That is why it is important to know whether
the fund is sticking to its objectives.
Investors need to be aware of
their investment objectives before they select a particular type of
scheme. For example, Sundram Rural India Fund invests in companies that
are focusing on Rural India. HDFC Top 200 states its objective as
generating capital appreciation from stocks in BSE 200 Index.
Let us
suppose, an investor who has a low risk appetite and who wants good long
term returns, should avoid investing in mid-cap funds, like Sundaram
Select Midcap or Birla Midcap, who predominantly invest in mid-cap stocks
and churn their portfolios in an aggressive manner. Mid-cap stocks are
considered more volatile than large-cap stocks.
In bull markets, mid-cap
stocks outperform large-cap stocks, however, in bear markets, mid-cap
stocks fall much more heavily than large-cap stocks. If one looks into the
portfolio of the fund, one can have a better idea of stocks and sectors
that the fund is invested in. The portfolio of stocks can be compared over
different time periods.
3. FUND MANAGER’s TRACK RECORD: Equity Fund Managers, like, Prashant Jain, K N
Siva Subramanian, Sukumar Rajah, Anoop Bhaskar, Sandip Sabharwal, etc.,
have rewarded investors with excellent returns through funds managed by
them.
It is the ability of the fund manager to foresee the trends much
earlier than others that sets them apart in the crowd. Fund management
requires real talent, creativity and sharp focus with a keen eye on market
dynamics.
Dhirendra Kumar, CEO, Value Research, says, “The continuity of
fund managers is important. It is not a coincidence that in some of the
great performing funds in the country over the past ten years, the common
element is continuity of fund manager.”
Prashant Jain (HDFC Mutual Fund)
looks for sustainability. His biggest success thus far has been his call
on technology in 1999. Jain sensed the fall six months in advance and sold
off tech stocks from his portfolio. Sanjay Dongre (UTI Mutual Fund) picks
stocks which exhibit high growth visibility. He has consciously avoided
metal stocks.
K N Siva Subramanian (Franklin Templeton) looks for
companies with quality management. He follows a blend of growth and value
style of investing and holds to his stocks for long term. He says, “If the
management and business are good, one can hold on to a stock even if the
stock valuations run ahead of fundamentals for a while.”
Contrastingly,
Anoop Bhaskar (Sundaram Mutual Fund) makes money by selling stocks when
they have reached their peak rather than holding on to them for long. He
opines, “There is nothing called long-term investing. We identify stocks
with a questionable management and low institutions holding. It may be
futile to attach too much importance to corporate governance.”
4. DIVERSIFICATION: Mutual funds are supposed to have a well
diversified portfolios. But, sometimes, it so happens, that the funds are
heavily concentrated in a particular sector or a stock, exposing the
investors to higher risk.
Kotak MNC fund is having an exposure of 28 per
cent (of total assets) in Basic/Engineering sector. Any adverse and swift
market reaction to Engineering companies is likely to expose the fund to a
steep fall in NAV. Taurus Starshare Fund holds 25 per cent in Jai Prakash
Associates. This excessive concentration may jeopardize the interests of
investors, when they look for a well diversified fund.
Another problem
with some funds is client concentration. It is highly likely that only a
few clients are available with funds having insignificant corpus. If a
client with a higher share of the fund exits, the performance of the fund
may suffer adversely.
However, SEBI had, a few years back, taken certain
measures to avoid such client concentration. Investors need to have a
close watch on any large erosion in assets under management (AUM) of the
fund. The history of mutual fund industry reveals that there are many
instances of funds losing up to 70-90 per cent of their total assets.
In
such circumstances, investors who stay on in the fund lose heavily. Over
diversification is also a problem with certain funds, like, Fidelity
Equity Fund which holds more than 120 stocks in its portfolio.
In addition to the above mentioned
parameters, it is advisable to use certain statistical measures also.
(i). Beta: Beta is a statistical tool, which
gives one an idea of how a fund will move in relation to the market. Beta
represents fluctuations in the NAV of the fund in relation to market returns. A
fund with a greater value of one is more volatile than the benchmark.
If a fund’s beta is one, it indicates that
the fund is closely following the benchmark. A low-beta fund will rise les than
the market on the way up and lose less on the way down. Similarly, a high-beta
fund will rise more than the market and also fall more than the market.
(ii). Sharpe Ratio: This ratio measures the
amount of excess return for each unit of risk taken by the fund. Risk in this
case is taken to be the fund’s standard deviation. Excess return is measured as
the difference in return generated by the fund and the return generated by the
risk free rate of interest.
A negative excess return indicates that the fund is
generating less return than the risk free rate. A Sharpe ratio is always used
as a measure of comparison between similar funds.
