Identify a good mutual fund? How easy it is? Is its easier than identifying a good stock.
This is also one reason why mutual fund investing is suggested for beginners.
But how to identify a good mutual fund?
I have seen people looking at last 3 to 5 years returns alone to identify good funds.
This is not wrong.
But that’s not the only perspective with which one should see mutual funds performance in particular.
Mutual funds are tailor made financial product. They are specifically designed to meet a objective.
A mutual fund giving 12% per annum return can be considers as good as a mutual fund giving 18% per annum return.
All mutual funds are different.
A mutual fund: (1) which is designed to generate regular income is different from mutual fund (2) designed to generate high long term returns.
If one will compare short term returns of type 2 fund with short term returns of type 1 fund, type 2 fund will look ugly.
If one will compare long term returns of type 1 fund with long term returns of type 2 fund, type 1 fund will look mediocre.
It is important for investors to first understand that one type of mutual fund cannot be compared with other type.
A debt linked fund cannot be compared with diversified equity fund.
A large cap fund cannot be compared with liquid.
So the first thing that my readers should remember is, one must compare apple to apple to identify a good mutual fund.
How to identify a good mutual fund?
(1) First Look at the fund manager..
Its is believed that, it is only wise to know about the CEO of a company before buying its stocks.
Fund manager is the CEO of his mutual fund.
Though its a team that manages a mutual fund portfolio, but the fund managers role is most important.
Fund manager is experienced and his decision can makes or break a mutual fund.
Checking the past history of the fund manager gives a hint about where this fund is heading in future.
Generally a fund manager manages more than one funds.
It is interesting to see other projects that he/she is managing.
Lets take example of HDFC Mutual Fund’s top fund manager Prashant Jain.
From this chart one can see that, Prashant Jain is handling 3 biggest mutual funds of Indian market.
Look the Asset Size of the following:
- HDFC Equity Fund (Rs 14.5K Crore),
- HDFC Top 200 Fund (Rs 11.6K Crore) &
- HDFC Prudence Fund (Rs 7.9K Crore).
Performance of these funds in long term (3 years) is also commendable.
Large sized portfolio & high returns is what investors like to see in a fund managers portfolio.
(2) Look at the Asset Size (AUM)…
In stock investing, we talk about blue chip companies.
Blue chip stocks represent all big and established companies.
In mutual fund industry, blue chips are those funds with considerable Asst Size (Asset Under Management).
Why asset size is important?
In mutual fund industry it is difficult to find names of investors.
Apart from you who is investing in your fund is not easy to find.
Suppose your mutual fund has a small Asset size.
In this same mutual fund, a big investor like (Jhunjhunwala) has also invested.
Such big investors invests with huge amounts.
Now, for some reasons Jhunjhunwala decides to exit this fund.
Such mutual funds with low AUM will immediately see its negative effect.
NAV of such mutual fund (low asset size) will crash to rock bottom levels.
But, when we are dealing with high asset size mutual funds, actions of few investors/agencies are not felt so much.
Hence one must preferable invest in large sized funds. Have your own list of large asset size mutual funds.
A typical example is like this:
Large asset sized mutual fund has their NAV more stable. This type of fund is great for beginners.
(3) Look at Expense Ratio…
In general, mutual funds with lowest expense ratio is considered good for beginners.
Such funds can generate higher returns with less risky portfolio.
I have discussed in detail about mutual fund’s expense ratio in part 2.
(4) Compare funds performance with its peers…
Comparing return of the mutual fund in consideration with its peers is great reference for beginners.
Comparing funds performance with the following reference parameters is advisable:
- Best Fund of its Category.
- Average returns of the Category.
- Benchmark of the Fund.
The fund is performing better than category average.
5 year return of category average is 5.7%.
Example fund is generating 7.4% returns which is better than category average.
Best of Category:
The fund is performing below par than the best fund of the category.
5 year return of category average is 19.5%.
Example fund is generating 7.4% returns which is much lower than the best fund of the category.
The fund is performing better than its benchmark.
5 year performance of benchmark is 6%.
Example fund is generating 7.4% returns which is better benchmark.