By Nilesh Naik, Head of Investment Products, Share.Market (PhonePe Wealth)

“Past performance is not an indicator of future returns.” If you are a mutual fund investor, most likely you would have come across this disclaimer which is self explanatory. However the reality is, most mutual fund investors still end up relying solely on the past returns to make their scheme selection. The reason – it’s a metric that is simple, objective, widely available and easy to understand. Besides, most investors are oblivious of other factors that are important to assess mutual fund schemes.

As Warren Buffet says “Risk comes from ignorance”. Thus, selecting mutual fund schemes purely based on past returns and ignoring everything else, is not a wise thing to do. So here are the five most important things that investors should assess before zeroing down on the equity mutual fund scheme to invest in.

1. Fund philosophy, investment style and process: When it comes to buying things like apparel, different people have different preferences. While some are very particular about the brand, style or quality of the product even if that means shelling out more money, others prefer to shop when there are big discounts. Likewise, funds and fund managers also have their own preferences or investing styles such as growth, quality, value and so on. For e.g. a Fund that follows a quality approach would invest predominantly in high quality businesses having high profitability, low leverage (debt to equity) and so on. On the other hand a Fund that follows a value style focuses more on owning businesses with attractive valuation in their portfolio. It is important for investors to understand the style that the Fund follows and make a choice based on their comfort with the investment style, prevailing market environment / outlook (to assess if it is conducive for the fund’s investment style) and how it fits in their overall portfolio.

2. Fund Manager / investment team experience and track record: Before you invest in a scheme, it is also extremely important to know about the fund manager and the investment team managing the scheme. The long term track record of schemes they have managed in the past (including performance of funds managed in their earlier organizations), alignment of the fund manager’s investing style with the fund’s style and the investment team’s stability are some of the critical aspects investors should assess.

3. Performance consistency: Instead of relying on point to point performance such as 1 year or 3 year returns, it is advisable to assess the performance consistency of funds across different time periods and market phases. One of the better ways to do this assessment is using rolling performance. Such performance consistency assessment should be based on relative performance vs the benchmark index and other schemes in the fund category. It is almost impossible for any fund to be consistently at the top of the ranking table since different investment styles tend to outperform at different times. Any scheme which has been in the top two quartiles most of the times can be typically considered as a consistent performer.

4. Performance attribution and risk: Understanding the sources and attribution of outperformance of a scheme is equally important –  whether it is on account of fund’s investment style, sector allocation, stock selection and so on. Such analysis also provides insights on the fund manager’s stock picking skills and how much risk the Fund has assumed to deliver outperformance. Other quantitative Risk / Risk adjusted measures such as Standard deviation, tracking error, Jensen Alpha, etc may also be handy to assess the Fund.

5. Fund size: Finally, it is important to ensure that the fund has a certain minimum fund size that is well diversified across a wide base of investors to avoid instability driven by large fund outflows. In some of the fund categories such as small caps where liquidity can be a significant constraint, it may also be advisable to avoid funds that are too large in size.

While the above evaluation parameters can help with the fund selection, it is also important to  assess whether the fund you choose fits in your overall investment portfolio. Your overall asset allocation strategy, number of funds in the portfolio, allocation to funds of different fund houses, etc. can all determine whether the selected fund merits a place in your portfolio or not. More importantly, assessing some of these parameters would require in-depth understanding of the investment domain, access to necessary data and analytical tools, in addition to time to conduct such assessment. For investors who find this to be a difficult exercise, it may be best to rely on experienced investment professionals to help select the right funds.

PhonePeWealth Broking Private Limited is a member of NSE & BSE with SEBI Regn. No.: INZ000302639, Registered Office Address: Office – 2, Floor 3, Wing A, Block A, Salarpuria Softzone, Bellandur Village, Varthur Hobli, Outer Ring Road, Bangalore South, Bangalore , Karnataka – 560103

Depository Participant of CDSL Depository with SEBI Regn. No.: IN-DP-696-2022, Research Analyst– INH000013387 and ARN- 187821. Member id : BSE – 6756 NSE 90226. PPWB acts as a distributor of Mutual Fund and WealthBaskets. Mutual Fund investments are subject to market risks, read all scheme related documents carefully. This content is exclusively for educational and informational purposes only. Disputes with respect to the distribution activity would not have access to Exchange investor redressal or Arbitration mechanism. Kindly refer to our website for more details.