Analysing mutual fund performance is a vital step for anyone looking to build wealth and achieving financial goals through investments. Understanding how to evaluate mutual funds ensures you make informed decisions to potentially earn optimal returns. With a thorough analysis of various performance indicators, you can choose best mutual funds that aligns with your financial objectives and risk tolerance, paving the way for long-term investment success.
Reasons to measure the performance of a mutual fund
- Informed decision-making: Understanding the history of a mutual fund through analysis helps you make informed decisions about where to put your money. This ensures you choose funds with a proven track record. You will also be able to avoid funds with inconsistent historical performance.
- Risk management: Evaluating performance and various risk parameters allows you to identify potential risks and adjust your portfolio accordingly. By recognising which funds are more volatile, you can balance the portfolio to match your risk tolerance.
- Goal alignment: Regular analysis ensures the mutual funds in your portfolio align with your long-term financial goals. This helps maintain a focused investment strategy, be it for retirement, education or other goals. It enables timely adjustments to stay on track with your objectives.
Parameters to analyse Mutual Fund performance
1. Compare the fund’s performance to that of its benchmark as well as peers
Understanding how to analyse Mutual Fund performance involves gauging how well the fund has performed relative to its benchmark and its peers in the category. A fund that consistently outperforms its benchmark and peers is generally considered a good investment. By assessing the fund’s performance vis-à-vis its benchmark and peers, you can determine the efficiency and reliability of the fund's management.
2. Check the expense ratio of funds
The expense ratio is the annual fee that funds charge you to manage your investments. Lower expense ratios are generally preferable as they allow more money to stay invested and grow. However, expense ratio should not be the sole criterion for buy or sell decisions. A low expense ratio isn’t always the best choice, and a higher expense ratio isn’t necessarily a bad one. It should be considered alongside the fund’s overall performance and other factors.
3. Check the fund’s historical performance across market cycles
You must review your mutual fund’s performance over various periods (1, 3, 5 and 10 years) to assess its consistency. Historical performance provides insight into how the fund has managed different market conditions, helping you predict future performance.
This long-term view highlights the fund's ability to endure and perform through economic downturns and market booms. Additionally, it allows you to see if the fund’s strategy remains effective over different economic cycles and managerial changes.
4. Check the strength of the portfolio
Assessing the quality and diversification of a fund’s portfolio is critical. A well-diversified portfolio typically helps mitigate risk and enhance returns. Examine the concentration of the portfolio among top companies and sectors to ensure it aligns with the fund’s investment strategy. A highly concentrated portfolio can result in greater drawdown during market volatility. For Debt Funds, evaluate the credit quality and maturity profile of the underlying debt securities.
5. Analyse the fund’s risk-adjusted returns
Risk-adjusted returns consider the amount of risk taken to achieve optimal results, offering a more comprehensive view of a fund's performance. This helps you understand whether the returns justify the risks involved:
- Sharpe ratio: It measures the excess return per unit of risk. Higher Sharpe ratios indicate better risk-adjusted returns. This ratio helps you compare funds with similar risk profiles. It is particularly useful in assessing the efficiency of a fund's investment strategy.
- Standard deviation: This indicates the volatility of the fund’s returns. Lower standard deviations suggest more stable performance. This metric helps in understanding the consistency of a fund's returns over time.
- Beta: It measures the fund’s volatility compared to the market. A beta less than 1 indicates lower volatility than the market. This metric is crucial for understanding how a fund might react to market movements. A low beta suggests that the fund is less likely to experience significant fluctuations in value during market swings.
6. Check portfolio turnover ratio (PTR)
PTR measures how frequently the fund's assets are bought and sold. A high turnover ratio can lead to higher transaction costs, which can reduce returns. It's important to compare the PTR with the fund's performance to ensure it justifies the costs. Frequent trading can indicate an active management style, which might be beneficial if it results in higher returns. However, you should be cautious of excessive turnover that doesn’t translate into better performance.
Also Read: How to invest in Mutual Funds in 7 easy ways
Conclusion
You can gain a comprehensive understanding of your mutual fund investments by evaluating its historical performance along with various parameters such as risk ratios, portfolio make-up, expense and portfolio turnover ratio among others. This holistic approach ensures informed investment decisions.
Disclaimer: This article is for information purpose only. The views expressed in this article are personal and do not necessarily constitute the views of Axis Bank Ltd. and its employees. Axis Bank Ltd. and/or the author shall not be responsible for any direct / indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information. Please consult your financial advisor before making any financial decision.
Mutual Fund investments are subject to market risk, read all scheme related documents carefully. Axis Bank Ltd is acting as an AMFI registered MF Distributor (ARN code: ARN-0019). Purchase of Mutual Funds by Axis Bank’s customer is purely voluntary and not linked to availment of any other facility from the Bank. T&C apply.
