There is a reason why the SEBI insists on every Mutual Fund advertisement to carry the disclaimer- Mutual Fund investments are subject to market risks. Please read all offer documents carefully before investing.
For many novice investors, a Mutual Fund represents an opportunity to earn returns on their surplus funds, with most choosing where to invest based on inputs from friends, family, distributors or simply from their own research.
Though there is nothing wrong in this, blindly trusting your family to make your investment decisions could backfire, if the fund doesn’t perform as expected for a long period. Before setting up that SIP or making your lumpsum investment, it doesn’t take much time to understand what’s behind the hood of your Mutual Fund, and the hidden factors that could affect your long term investments.
Risk-Adjusted Returns
Each company’s journey is full of twists and turns; sometimes there are bumper profits, while at other times, companies are preparing for future growth opportunities. For the Fund Manager, the real skill lies in understanding which companies are preparing for these opportunities and which are underperforming at the moment. This volatility is reflected in the Sharpe Ratio, where a higher ratio indicates how well the fund is converting risk into returns.
Besides that, you should also check the standard deviation of its returns from the benchmarked index; a smaller number shows a less volatile fund.
Consistency Across Market Phases (Rolling Returns)
The odds cannot always be in your favour, but that doesn’t mean the odds will always be in your favour. An experienced Fund Manager understands this and will work towards aligning the portfolio to offer consistent returns even during recessions. ‘One Hit Wonders’ do not work for Mutual Funds; they demand consistency over the years. The Fund’s rolling returns tell you how it has performed across multiple periods of recessions and booms, helping you understand how well the fund performs.
XIRR Returns
If you would like to invest in a Mutual Fund through a monthly Systematic Investment Plan (SIP) or invest irregularly, the true meaning of the Mutual Fund’s performance depends far more on consistency, as it behaves as a separate investment with its own timeline. In this case, the XIRR (Extended Internal Rate of Return) measures the actual annualised returns for the total investments made in the Mutual Fund.
Peer Comparisons
Every type of Mutual Fund targeted towards your risk profile competes with various others for your attention. Some silently offer consistent returns, while others get fairly popular over time. But popularity doesn’t always mean consistent returns. For example, if Fund A earns you 15% annually over a 3-year period, and Fund B earns 19.4% during the same period, what matters is how much both funds have outperformed the sector average.
In this case, if the sector average is 16%, Fund B is the clear winner, but the comparison also depends on how the Funds have performed over specific periods, the expenses they charge and the professional ratings they’ve received.
Asset Allocation Strategies
Every Mutual Fund invests in various asset classes and types of shares based on a designated risk profile. For instance, some funds invest only in safer, less volatile multinational companies, while others spread their investments across small and medium companies, debt instruments, market indices, commodity indices, and even real estate.
Fund managers who implement a consistent asset allocation strategy that captures growth opportunities despite market fluctuations remain highly sought after. But that again depends on how long the fund manager remains with the team, and if his replacement manages to continue with the good work.
<p>The post 5 things to see beyond backdated returns in a Mutual Fund first appeared on Hello Entrepreneurs.</p>
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