Key Message: Best mutual fund scheme does not mean the best in returns, but the one best suited to your risk profile and goals and the one that is good in its peer group.

The biggest mistake that mutual fund investors make is selecting mutual funds only on the basis of performance and that too just the recent performance. There are some investors who consider only the star ratings given by various research agencies. These star ratings can be one of the factors to look at, but there are many other parameters that one should look into before finalising a mutual fund portfolio.

The most important first step is to have an investment goal. A fantastic fund selection done without having an investment goal is completely useless. You should know the reason for your investment, how long you can be in the investment, at what stage you will re-allocate, etc. before you make your first investment. Once you know your investment objective, you may evaluate a fund by parameters as mentioned below.

Performance Ranking

More than the recent or long term performance of any scheme it’s ranking among peers is very critical. Firstly, you must compare the mutual fund with its peer group. Secondly, you must compare the performance of the scheme with its benchmark. You can find the information on the benchmark in the mutual fund offer document.

The fund which has performed well in one quarter may not perform well in the next quarter. Funds with a good long term top quartile performance are far superior to a fund scheme which has one top position and one bottom position.

Total expense ratio

As a fund starts to do well, it should attract a lot of investors, and as its assets increase it should keep dropping its asset management charges. Look at well managed funds with charges below 1.9% p.a. – there are many. Though mutual fund’s total expense ratio has been capped by SEBI, still lower the better unless we get some extraordinary return by paying higher expenses for fund management.

Fund manager tenure and experience

Fund manager plays a very important role in the fund’s performance. Though it is a process oriented approach but still fund manager is the ultimate decision maker and his experience and view point counts a lot. You should know who the fund manager of the scheme is and what his past track record is.

If you find that due to change in the fund manager there is considerable effect on the fund’s performance which does not suit your risk appetite then you may make a decision to exit.

Scheme asset size

Less AUM in any scheme is very risky as you don’t know who the investors are and what quantum of investments they have in this particular scheme. Exit of any big investor out of any mutual fund may impact its overall performance very badly and the remaining investors in a scheme will have to bear the impact.  In schemes with larger AUMs this risk gets minimised.

A good fund manager will automatically result in better performance and thus improve the quartile ranking and would also generate returns better than the benchmark. High scheme assets will help in reducing the total expense ratio of the scheme.  One should review the current selection every quarter or half yearly.

It is recommended to invest in two to three funds that match and/or complement your investment objective. This is to avoid dependence on any one fund and avert risks of market downturns. You can always split the pie as 60:40 with two funds and 40:30:30 in case of 3 funds.

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