Work your Way up with your Wealth building Winners! (Contd.)

Work your Way up with your Wealth building Winners! (Contd.)

Performance Evaluation of Mutual Funds (contd.)

Past Performance of the Fund

Though past performance alone cannot be indicative of future performance, it is, frankly, the only quantitative way to judge how good a Fund is at present. By looking at the performance of Mutual Funds over different periods, you can select consistent performers.

Compare returns across Funds within the same category

Compare apples with apples and not with oranges i.e. compare Funds within a category. For instance, if you are evaluating Sundaram Select Midcap Fund for investment, you should compare its returns with other predominantly mid cap diversified equity funds. Comparing it with large cap funds, will deliver erroneous results, because the risk-reward relationship between mid cap and large cap funds are not comparable.

Compare returns against those of the benchmark index

Regulations demand that every Fund mentions a benchmark index in the Offer Document. The benchmark index serves the dual purpose of being a guidepost for both the fund manager and the investing community. All eyes must be on the benchmark index and how the fund has fared against it. During market turbulence, like the one witnessed over May-June 2006, you will find many equity funds trailing their benchmark indices. The funds that can outperform their benchmark indices during stock market volatility must be marked closely.

Compare against the fund's own performance

Besides comparing a fund with its peers and benchmark index, you should evaluate its historical performance. Not all funds show stability in performance over the years. Many of them slip up; only a few manage to sustain the good work they have done year after year, market cycle after market cycle.

As equities are best equipped to deliver returns over longer time frames (3-5 years or even more), investments in diversified equity funds should be made with a long-term perspective. Comparing a fund over a longer time frame will also give you a good idea about how the fund has fared over a stock market cycle (boom and bust).

Do not overrate past Fund performance

One of the most common ways of selecting a Mutual Fund is to invest with the crowd in today's hot funds. Unfortunately, jumping from one winning fund to another is a recipe for disaster. Buying the equity fund that was yesterday's best-seller is not a strategy that produces excellent returns. You do not have to go fully in the opposite direction and ignore these hot funds, but you should understand their limitations and strengths. They became best-selling funds because they have merit, but you have to assess that merit in the context of your own well-diversified portfolio, and not the crowd's current investment trend.

Use past performance to determine consistency and risk

There is an important role that past performance can play in helping you to make your fund selections. Returns for mutual fund schemes are displayed on a compounded annualised basis, especially for periods in excess of one year. While the need to present the returns in the given form is a statutory requirement, you should realise that returns computed using the compounded annualised growth rates (CAGR) can present a distorted picture. CAGR provides a smoothed return i.e. the steady rate of growth. A strong surge at the end of the period can have a positive impact on the historic returns as well. While you should disregard a single aggregate number showing a fund's past long-term return, you can learn a great deal by studying the nature of its past returns. Above all, look for consistent performance.

In using the word performance, I am not limiting my interest solely to return. Risk is a crucial element in investing and the subject matter of the next blog.

Work your Way up with your Wealth building Winners! (Contd.)

Work your Way up with your Wealth building Winners! (Contd.)

Mirror, mirror on the wall, which is the best Fund of them all?

This seems to be the daunting question in the minds of all investors planning to park their money in Mutual Funds. The answer lies in systematically scouting for consistent performers with sound credentials.

Performance Evaluation of Mutual Funds

Reputation of the Asset Management Company and that of the Fund Manager is of paramount importance in evaluating a Fund. Selecting the right Fund can be quite challenging. There are two reasons for that - one is the large number of Funds in India today that could confuse you. The other reason stems from the first - more Funds imply more homework on your part. To identify the right Fund, you need to see how the Fund measures up on the following parameters.

Fund's background

Check out as to whether the sponsors have adequate fund management experience, are conservative and innovative and have a clean slate untainted by scams and financial irregularities.

The Fund house's overall performance

Even if you wish to invest in just one scheme of the fund house, you must check to see how the fund house is performing as a whole.

Fund manager's track record

The following factors will aid you in gauging the ability of the fund manager to demonstrate sterling performance.

History of managing funds

You can determine how effective a Fund Manager has been in earning superior returns at lower risk after studying the previous funds managed by him either in the same or a previous AMC.

Adherence to mandate

It is common knowledge that every mutual fund scheme has an investment objective, which becomes the fund manager’s mandate. But the million-dollar question is does he abide by the mandate?

Investment by the Fund Manager in his own schemes

It is one thing to systematically plan how to invest other people’s money and totally another to actually apply the same plan to one’s own money. In India, unlike in the USA, it is not mandatory to report whether the fund manager invests his own money in the schemes he manages.

Process-driven or Fund Manager-driven
Is the fund manager driven by his own individualistic style while taking investment decisions or are there processes and systems in place to make investments? Looking at the fund’s trailing 5-10 months’ portfolios will allow you to understand the fund manager’s style of investment over a period of time. A fund manager’s investment philosophy (concentrated bets, diversified portfolio, large caps, mid caps) gives the fund a particular risk profile. It is always ‘safer’ to select an AMC that has a strong, process-driven investment style and the fund manager’s role is to perform within the parameters defined by the AMC. The fund manager should be able to seamlessly enter and exit from the AMC without disturbing the process. It is advisable to check the number of schemes your fund manager is handling. If the fund manager has a team of analysts in place, then even a larger number of schemes under him would seem fine. While there is no definite number or ideal team size, it helps if there are enough members in the fund management team so that no individual is indispensable.

Risk mitigation is a very critical part of fund management and its primary objective. Delivering growth comes after that and is therefore the secondary objective. Both these objectives are tested vigorously across bull and bear phases. And more often than not, you will find the process-driven funds redeeming themselves on both these criteria more than the ‘fund-manager’ driven funds. From your perspective, the moot point is – how does one identify a strong process-driven mutual fund? You can do that by looking at consistency in the fund’s performance across a longer time-frame of 3-5 years. More importantly, within this period, try to see how the fund has done across bullish and bearish phases. In a strong process-driven mutual fund you will find that even if a fund has not done exceedingly well in a bull run, it would have mitigated losses in a bearish phase. The reason behind this is disciplined fund management, a rare trait in the industry.

Work your Way up with your Wealth building Winners!

Work your Way up with your Wealth building Winners!

Mutual Funds are proven winners and one of the best ways for the small investor to build wealth while managing risk. As already discussed, a firm foundation can be laid by defining and articulating your investment goals and identifying the types of funds you need to reach your goals. But the key to finding the right Mutual Fund is to

Research your resources…..

Every financial daily offers daily NAVs of all Mutual Fund schemes. Magazines also come out with annual survey of Mutual Funds. There are even magazines dedicated entirely to the Mutual Fund industry. Internet is indeed a great place for information. There are dedicated sites as well as financial sites, which offer information on Mutual Funds. The Mutual Funds themselves maintain websites which are a veritable treasuretrove of resources.

Prospecting the Prospectus seems to be the key to catapulting yourself to the winning position with precision.

The Prospectus or the Offer Document explains the financials, performance, objectives, fees, risks associated with a fund and legal issues. This document is as comprehensive as an encyclopedia. However, funds also offer a simplified "fund profile" known as the Key Information Memorandum (KIM) that covers the highlights in a few pages. For most investors, the KIM should suffice. But you should also be aware of the Offer Document.

Nobody wants to read the Offer Document. It is a document that describes a Mutual Fund, often in legal and financial terms that may sound awfully technical. But the language is precise for a reason. The SEBI has strict guidelines about what the fund can say about itself and how it must present information. Remember, the SEBI's approval of a prospectus is only that. It is not an endorsement of any particular investment. Simplifying a prospectus is never easy because it is a document that is trying to serve two purposes. Its stated objective is disclosure: informing investors how a fund invests and operates. But it is also a document that mutual fund company lawyers design as a litigation shield, making sure the fund managers will be able to run the fund without inviting lawsuits.

Don't let the Offer Document unnerve you. The financial matters and investment policies may be unique. But much of the other material is boiler-plate and doesn't vary much from fund to fund. And not all of it is pertinent to every investor. When thumbing through the Offer Document, look for important statistical nuggets like the fund's condensed financial history, fund performance (showing the average annual total returns and cumulative total returns for the fund over various fiscal-year periods) and the investment policy section (outlining the overall strategy, the permitted investments in the broadest of terms and restrictions, if there are any). Pay careful attention to the investment objective and how the fund managers plan to achieve it, especially the kind of risk they might undertake (with your money). Be forewarned. Most fund prospectuses are written in a way that gives fund managers the widest latitude and discretion The information in this section helps to describe the fund's character. The document plainly lists all sales charges, deferred sales charges, redemption fees, exchange fees, management fees and other pertinent expenses. It also outlines the various options available to investors like Growth, Dividend-reinvestment and Dividend Payout. (These options will be explained and analysed in the context of tax implications in the forthcoming blogs.) Last but not the least, the risk factors will be stated in no uncertain terms.

You are not going to have trouble finding out details about any fund, so you need to know what to concentrate on rather than risk information overload. Look out for the signs of a well-managed fund. You should focus on a fund's performance, consistency and management.

Evaluating a Fund’s performance will be dealt with in detail in the subsequent blogs.

Ground Rules for Mutual Fund Investing

Ground Rules for Mutual Fund Investing

Having demystified the concept of Mutual Funds, let us now traverse the investment jungle!!!

How can you tell whether a particular Mutual Fund is right for you? The only sure way is to become familiar with the language used in the Fund industry and to have a sound investment strategy. Throwing your money haphazardly into investments that you don't understand is a sure way to lose it quickly. Does this mean that you should keep your money safe by putting it under the bed or keeping it in the bank? No – all you need to do is set the ground rules for successful investing.

First and foremost, you have to define your investment objective.

Successful investing is a journey - not a one-time event - and you need to prepare yourself. What is your destination? How long will it take you to get there? What resources will you need? These are questions you must first ask yourself. The plan that you come up with will depend on your investment goals. Nobody knows you and your situation better than you do. Your financial goals will vary, based on your age, lifestyle, financial independence, family commitments, level of income and expenses and a whole host of factors.Therefore, the first step should be to assess your needs. You can begin by defining the investment objectives, which could be regular income, buying a home or financing a wedding or educating your children or a combination of all these needs.

Define your cash flow requirements.

A careful assessment of your investment objectives will enable you to estimate the amount of money you require for satisfying your various needs at different points of time in your life.

Determine your risk appetite

Your objectives should be realistic and move in tandem with your risk tolerance. How much, or how little, of risk can you take? If you are unable to stomach the constant volatility of the market, your objective is likely to be safety or income focused. However, if you are willing to take on volatility then a growth objective may suit you. Taking on more risk means you are increasing your chances of realizing a loss on investments, as well as creating the opportunity of greater profits.

Identify Funds with matching Investment Objectives

Finally, zero-in on the Mutual Funds that meets your risk tolerance (needs) and risk capacity (budget) levels. If your aim is to increase the value of a portfolio through Mutual Funds, look for Growth Funds that focus on capital appreciation. If you are income-orientated, you will want to choose funds with dividend-paying stocks or Bond Funds that provide regular income. (You have already been exposed to the various types of Mutual Funds. This will come in handy here.)

Making informed investment decisions entails not only researching individual Funds but also understanding your own finances and risk profile. To get an estimate of the schemes suitable for certain levels of risk tolerance and to maximize returns, you should have an idea of how much time and money you have to invest and the returns you are looking for.What you achieve as an investor will depend on your goals, but sticking to these simple steps will help keep you on the right path. Bon voyage!

Why Choose Mutual Funds?

If you are looking for a good investment "story", buy a stock. If you are looking for a smart investment, buy Mutual Funds. Strange as it may seem (since Mutual Funds are primarily composed of stocks) such a distinction succinctly underlines the fact that there are some notable advantages to using Mutual Funds.

Professional Management

When you buy a mutual fund, you are enlisting professional help at an especially inexpensive price. Mutual fund managers choose securities to buy or sell based on their years of experience in the markets and on research specific to individual stocks, in keeping with a mutual fund's objective as stated in the Prospectus. Therefore, instead of you making decisions based on gut-feel or what someone told you, you simply leave your investments in the expert hands of professional fund managers, who invest your money on the basis of minute analysis and astute investment strategies. The convenience of mutual funds is undeniable - you don't have to micromanage the portfolio yourself . You save your time, besides not having to time the market.

Diversification

To achieve a truly diversified portfolio, you may have to buy stocks with different capitalizations from different industries and bonds having varying maturities from different issuers. For the individual investor this can be quite costly. This is where Mutual Funds pitch in. Spreading fund assets among different investment vehicles, and different stocks in a variety of industries with different rates of return, helps offset losses in one investment with gains in another. To diffuse your risk while increasing your potential for return, choose a variety of well-performing funds with different objectives and different investments.

Economies of Scale

Mutual funds are able to take advantage of their buying and selling size, thereby, reducing transaction costs for you. In addition, the low cost per individual can be attributed to the cost of trades being spread over all investors in the fund.

Affordability - A better portfolio for less money

The minimum initial investment for a Mutual Fund is fairly low for most funds (as low as Rs 500

for some schemes). Investors individually may lack sufficient funds to invest in high-grade stocks. Say you want to invest Rs.5000 in a top notch software company. You find that it is not enough to buy even one share! If you invest that same Rs.5000 in an Information Technology Mutual Fund, you get yourself a proportionate share in a large number of premium software scrips!

Impartiality

Wealthy stock investors get special treatment from brokers and wealthy bank account holders get special treatment from the banks, but mutual funds are non-discriminatory. It doesn't matter whether you have Rs. 500 or Rs. 5,00,000, you are getting the same manager, the same account access and the same investment.

Liquidity

You can sell your Mutual Funds on any Business day and receive your current market value of investments within a short period of time (3 to 5 days) thus maintaining immediate access to capital.

Transparency

Two key documents - the Prospectus (legal document) and shareholder reports (normally quarterly) highlight the fund’s strategy and performance. You get regular information on the value of your investment in addition to disclosure on the specific investments made by your scheme, the proportion invested in each class of assets and the fund manager's investment strategy and outlook.

Choice of Schemes and Flexibility

Mutual Funds offer a family of schemes to suit your varying needs over a lifetime. You determine your own needs and risk tolerance and then choose a mutual fund that fits your financial goals. You can transfer a part or all your investment from one fund to another when your goals change over time.

Well Regulated

All Mutual Funds are registered with SEBI and they function within the provisions of strict regulations designed to protect the your interests as investors.

As with any investment, there are risks involved in buying mutual funds. These investment vehicles can experience market fluctuations and sometimes provide returns below the overall market. Mutual fund returns are not guaranteed. Also, the advantages gained from mutual funds are not free: many of them carry loads, annual expense fees and penalties for early withdrawal.

To maintain liquidity and the capacity to accommodate withdrawals, funds typically have to keep a large portion of their portfolio as cash. Having ample cash is great for liquidity, but money sitting around as cash is not working for you and thus is not very advantageous.If we cautiously approach these caveats, the advantages far outweigh the disadvantages and elevate Mutual Funds to the status of a preferred investment vehicle.