Here's how to choose the best mutual fund for your portfolio

There is no dearth of funds in the market and they all clamour for attention. Choosing a mutual fund appears to be mighty complex but keeping a few handy tips as outlined below can help you know which mutual fund is best for you.

Anil Rego, CEO, Right Horizon said investors should look at expense ratio (cost of investment), downside and upside capture ratio (how the portfolio performs in bear and bull markets), portfolio turnover (for understanding whether fund manager trades a lot), and the fund's track record in terms of outperformance over benchmark (creation of alpha). “All these parameters should be looked at individually and then compared with the fund's category peers. This will give a wholesome picture of the fund,” he said.

At a basic level, the return that a fund gives over a given period is just the percentage difference between the starting Net Asset Value (price of a unit of a fund) and the ending Net Asset Value.

Returns by themselves don't serve much purpose. The purpose of calculating returns is to make a comparison. Either between different funds or time periods.

Samant Sikka, Co-Founder, Sqrrl Fintech Pvt. Ltd said that one should look at absolute returns which measures how much a fund has gained over a certain period. Therefore investors should look at the NAV on one day and then after six months or one year or two years later. The percentage difference will give you an idea of the return over this time frame.

“Also, while considering the returns of a diversified equity fund (one that invests in different companies of various sectors), compare it with other diversified equity funds. Don't compare it with sector specific fund,” he added.

On the other hand, you should also look at the benchmark returns which indicates what the fund has earned as against what it should have earned. The market watchdog SEBI makes it mandatory for funds to declare a benchmark index. In effect, what the fund is saying is that the benchmark returns are the target it is gunning for and a fund can pat its back if it manages to beat the benchmark.

Let's say an equity fund is a diversified fund that has benchmarked itself against the BSE Sensex. In such a case, the returns of this fund will be compared with the Sensex.

If you are investing in a mutual fund for a longer period say 5-10 years, knowing what is being charged is critical.

Expense ratio: This is what a fund charges you in a year for managing your money. “Expense ratios and direct funds can amplify compounded returns much more than funds that have higher expense ratios," said Sikka.

Minimum initial investment: This is the minimum amount that you can invest in a fund. This may vary from fund to funds.

The portfolio turnover helps in determining the mutual fund's holdings, that is, the total stock it holds during a year. The higher the turnover rate, the greater will be the turnover. This means the expense ratio of the fund will increase which may lead to poor performance of the scheme. Compared to value-oriented fund growth funds generally, have a higher turnover rate.

Selecting funds with the right investment objective and suited towards your goals should be the deciding factor. It is important to understand that the risk factor varies from fund to fund. Thus, while making a selection of funds, you need to first analyse your goals time period and goal cost before making an investment in any of the funds.

Sikka said that a diversified portfolio has a lower risk than a portfolio biased towards a particular stock, an asset class or a sector. “You should also be aware that there is no advantage in over diversifying your investments. A maximum of let’s say 2-3 equity schemes is more than enough,” he said.

A fund manager's track record is also a good factor where you can get to know the weight of the fund and analyse its performance while comparing it with the peer groups. The longer a manager has been with a fund, the better it is for him/her to analyse and understand the fund’s future performance.

How well a fund faces economic headwinds is critical. Rates of return since launch and comparison with funds that had to face bad markets is unfair. If a fund has proved its mettle in a bear market, then the fund and its managers deserve a thumbs up.

Source: Moneycontrol.com