A simple guide to spotting the right mutual fund scheme

If you want to buy an electronic gadget, say a smart phone, how do you go about selecting the right one? The market is flooded with various brands and products with different specifications and features. To select the right one that perfectly fits your​​ requirement and liking, you will have to do a detailed research. Similar is the case with the mutual fund investing, too. Mutual funds offer a wide variety to investors – there are various categories of funds (such as equity, debt, hybrid, FoFs and ETFs) and, within them, various schemes. Often, selecting the right scheme, much like selecting the right phone, can be very confusing for investors. But, in fact, the task is not that complex – if you adopt a holistic approach by analysing your own personal parameters and scheme-related factors. Here we list some of the pertinent factors based on which you can select both, the fund category and scheme that suit you. However, remember scheme selection is not a one-time process. You need to review your investments periodically to opt out of underperforming ones and to replace them with good performers. This is important in attaining your financial goals. ​​​​​​​

Personal factors – goals, investment horizon, risk appetite

Friends, relatives or articles in financial dailies often influence our investment decisions. We tend to buy schemes bought by our friends or relatives or those are making headlines, forgetting that every individual’s financial needs/ goals and risk profile are unique. So, the first criteria – and the most important one at that – is to decide your own financial goal. You should choose schemes that match your goal. Such an approach can help you move steadily towards your goals.

As seen in the table below, investors who require funds for short-term goals, such as payment of utility bills or children’ tuition fees, and those with low risk appetite can consider investing in liquid or ultra-short-term debt fun​ds. Those with moderate risk profile and medium-term horizon can invest in hybrid funds. These funds, being a mix of equity and debt, could be useful in taking care of ageing parents or buying a new vehicle. For long-term goals such as creating a corpus for the retirement life or buying a house, equity funds are the best option. Investing in equity for long horizon can benefit from compounding and even out the risk associated with the asset class. Mutual funds also enable investors to do tax planning via equity-linked savings schemes (ELSS). There are gold fund of funds and Exchange-Traded Funds (ETFs), also known as paper gold, that make investing in yellow metal convenient. Further, there are index funds that are a good passive investing avenue.

Categories of funds and type of goals achievable by investing in them

Source: CRISIL Research

Goal-based investing will help investors choose right schemes in line with their own risk profile and investment horizon. Risk profile comprises two parts – risk appetite (willingness to take risk) and risk tolerance (willingness to bear the risk). Both vary with individuals. Important factors that determine risk profile are age, income, expenses, financial responsibilities, liquidity needs and time horizon.

In order to choose a scheme aligned with own risk profile, returns expectation and i​nvestment horizon, investors can take help from financial advisors or do it themselves.

Key scheme-related factors

Scheme’s relative performance – Importance of consistency notwithstanding, investors should compare a fund’s performance with schemes within the category and the respective benchmark in different market phases. Such a comparison has become easier after the Securities and Exchange Board of India (SEBI) re-categorised and rationalised schemes in 2018.

Fund manager’s track record and experience – A fund manager’s track record in managing various schemes in the same fund house, in previous stints, and across market phases, can give insights into his/ her expertise in managing portfolios. A seasoned fund manager, supported by robust investment processes and risk management practices, is better positioned to deliver reasonable risk-adjusted returns.

Portfolio parameters – Portfolio components, such as sector and company diversification, and liquidity of the underlying stocks, also boost the quality of a portfolio. While SEBI has capped sectoral and company holdings within a portfolio of funds, these parameters identify the risk of concentration and illiquid stocks.

Additionally, scheme selection should factor in portfolio management style and assess whether alpha generated over the benchmark is attributable to sectoral allocation and/or stock selection. Further, it is important to assess whether portfolio performance is derived from skill or luck by analysing sources of returns.

Besides, investors need to look at asset under management of the fund house and also check the facilities - advisory, research and administrative – it offers.

Risk attributes and cost – Sometimes, returns come at a cost that might not be visible to the naked eye. So, investors should look for the risk-return attributes of a scheme. Notably, risk-adjusted measures such as Sharpe ratio and information ratio, which not only look at the upside but also give due importance to the downside, are important performance metrics to evaluate the relative performance of a scheme.

Figure out the costs incurred in terms of exit load (charged whe​n an investor sells the investment, usually in a very short period of time), stamp duty levied and/ or annual expenses of the fund (administra​tive costs, management fees, etc). Carefully evaluate the tax implication which is governed by the type of fund investor type and investment horizon.

Summing up

Based on these parameters, investors will be able to choose a good quality fund but they have note that volatility in the performance of the underlying asset classes due to unprecedented events (such as the Covid-19 pandemic, regulatory changes etc) can dampen the performance of the funds in the short run. In such situations, investors should stay calm, keep abreast of the latest developments and hold on to the investment for the long term.

Disclaimer: Any comparison/data mentioned in this material is for general information only and not intended to be relied upon as investment advice and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. Information and content herein have been provided by CRISIL Research, a Division of CRISIL Limited, and is to be read from an investment awareness and education perspective only. Recipient are advised to seek independent professional advice before making any investments. The views / content expressed herein do not constitute the opinions of SBI Mutual Fund or recommendation of any course of action to be followed by the reader. SBI Mutual Fund / SBI Funds Management Private Limited is not guaranteeing or promising or forecasting any returns.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

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Investors should deal only with registered Mutual Funds, details of which can be verified on the SEBI website (https://www.sebi.gov.in ) under ‘Intermediaries/Market Infrastructure Institutions’. Please refer to website of mutual funds for process for completing one-time KYC (Know Your Customer) including process for change in address, phone number, bank details etc. Investors may lodge complaints on https://www.scores.gov.in against registered intermediaries if they are unsatisfied with their responses. SCORES facilitates you to lodge your complaint online with SEBI and subsequently view its status.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
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An investor education initiative, SBI MUTUAL FUND.
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