Personal Finance: What must you read in a mutual fund before investing in it?

Mutual funds differ because of portfolios and risk-return valuations, so before you purchase one, you need to assess and evaluate these aspects
Since the start of this year, asset management companies have announced roughly 100 new mutual funds with each fund catering to different investors with distinct risk profiles. (FILE)
Since the start of this year, asset management companies have announced roughly 100 new mutual funds with each fund catering to different investors with distinct risk profiles. (FILE)
Published on Sep 26, 2021 04:57 PM IST
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By Abeer Ray, Mumbai

Since the start of this year, asset management companies have announced roughly 100 new mutual funds with each fund catering to different investors with distinct risk profiles. Many of the new fund offerings (NFO) were cheaper with low net asset values (NAVs). Offers of low NAV have enticed many laymen investors blissfully unaware of the details that must be looked into before investing in mutual funds. While a low NAV justifies the rupee cost averaging approach and helps accumulate more units initially, there are hard facts that one must not ignore while reading a fund to evaluate its prospects. Mutual funds differ because of portfolios and risk-return valuations, so before you purchase one, you need to assess and evaluate these aspects:

Check for different risk levels

The risk factor is different for all mutual fund categories. You must check if the mutual fund is very risky, moderately risk or entails low to moderate risk. For example, many people unable to trace and track stock market movements prefer investing in equity mutual funds. Though these are less risky than direct investments in shares and stock, they come with a certain quantum of risk. Before investing in any mutual fund, check for the inherent risk in the pictorial representation of the risk called riskometer. Every mutual fund scheme has a level of risk assigned to it in the riskometer – view that carefully before investing.

Portfolio matters

Usually, we talk about portfolios while planning an investment basket or investing in our choice of stocks as per our risk appetite. But did you know that you must also check the portfolio of a mutual fund to check the sector it is invested in the most? Take for instance two midcap funds. Axis Midcap Fund focuses more on financial services sector with up to 17.49% invested in those stocks, while IT stocks constitute 13.97 % of the total allocation. Compared to this, Kotak Emerging Equity Fund has no IT stock and its investment in financial services sector is 12.47 % of its total portfolio allocation. Knowing the sectors that a mutual fund invests in allows you to make informed decisions: what’s happening currently in the IT and financial sectors? How would stocks in companies from these sectors perform differently from that of the hospitality sector or any other that has been marred under the pandemic effect.

Quality of stocks

Check for the quality of stocks in the portfolio. Follow the list of names of the companies and the percentage of investments made in them. For example, stocks of TCS, L&T Technology Services, IRCTC, SRF Limited, Godrej Real Estate, etc. are expected to yield higher returns in the long run owing to the nature of their businesses or enjoy monopoly status in today’s times. Check if the highest quality of stocks top the list as their presence in the portfolio reflects the ability of the fund to deliver superior returns on the amount invested. The quality of stocks in the portfolio would be reflected in the returns that underscore your portfolio performance.

Direct plans versus regular plans

While buying a mutual fund scheme, you will be given the option to choose between direct and regular mutual funds. Basically, these differ only in terms of their expense ratios. As is evident from their higher NAVs, direct plans generate higher returns compared to regular plans. The expense ratio of the former is lesser than the latter. This is because direct plans can be invested in sans any intermediaries while the regular plans involve buying through an agent or broker and hence involve commissions and brokerage charges.

Consistency of returns

Past performance is not the hallmark of guaranteed returns in future. A mutual fund earning 17% returns in one year that goes down to 10% in the next year is a cause of concern. Compare this with a mutual fund that has been giving 10% returns year on year. Consistency in performance is important as it underscores the fund manager’s ability to hedge risks while earning good returns that beat inflation. A consistent fund has better chances of delivering better returns every year for a prolonged period.

Fund Manager Performance

Performance evaluation of a fund is the key to evaluating a fund manager’s skills. Superior returns of a fund reflect the skilled fund manager’s ability to manoeuvre through the oscillating stock market movement, especially, during situations like the stock market crash in March 2020. Do a background check of the fund managers attached to the mutual fund to ascertain their ability to earn high returns in sync with your financial goal.

NAV performance

Many people shy away from investing in mutual funds with higher NAVs. Comparing NAVs is futile as mutual funds with the same portfolio will yield similar returns. However, some funds perform better than others or have more assets under management, thus, explaining their higher NAVs. There is a common misconception that mutual funds with lower NAV are cheaper, and hence, better. Also, just because some mutual funds have high NAVs, they must not be ignored.

Periodic rebalancing

Never invest in a single mutual fund alone just because its portfolio and scheme details match your financial goals. Check different mutual funds, their portfolios and decide how they can add value to your investment goals. Before you start investing, check for the asset allocation in these mutual funds. Besides, you must frequently visit to check how your mutual funds are performing. Also, do periodic rebalancing of your funds based on your new goals, which means redeem a non-performing fund to invest in a fund that promises higher valuations.

Personal Finance is a weekly feature that aims to provide our readers pertinent and helpful financial information

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Monday, October 25, 2021