If you think that just investing in mutual funds is enough to potentially grow your money over time, that is not true. Making the investment is just one element of the process. Selecting a suitable scheme and regularly monitoring and evaluating its performance are equally essential. Therefore, it is crucial to know how your mutual funds are performing and whether you should continue with your current investment, switch funds, or rebalance your portfolio.
In this article, we will explain what mutual fund performance is, how to evaluate it and why it is important to review your investments periodically.
Explaining mutual fund performance
Mutual fund performance refers to the potential returns that a mutual fund has delivered over a specific period. It indicates whether the fund has met or exceeded investors' expectations. Several factors influence mutual fund performance, including market conditions, fund management, asset allocation and expense ratios.
A well-performing mutual fund is one that has the potential to outperform its benchmark and category peers in the long term, without taking on undue risk.
While assessing a fund’s performance, it is important to note that occasional short-term dips can happen for several reasons, such as market volatility, macroeconomic shifts, temporary underperformance of a few sectors in a portfolio. In some cases, the fund manager may have a strategy that has the potential to deliver returns in the long-term but may not show immediate gains. Thus, brief underperformance may not reflect the fund’s true potential. However, if a fund consistently underperforms over the long term — especially across market cycles — it may be a sign to reassess its suitability in your portfolio.
Read Also: What is a mutual fund: Meaning, types, and benefits
Evaluation of mutual fund performance
Check the historical returns
First of all, look at the fund’s historical returns* over different time frames, such as 1 year, 3 years, 5 years, and 10 years. Compare these returns with your investment objectives and expectations. A consistent performer over a long period may be more suitable than a fund with high short-term gains but inconsistent performance.
*Past performance may or may not be sustained in future.
Compare with similar funds
Compare the mutual fund with other funds in the same category. Look at funds with similar investment strategies and asset classes to get a fair comparison. If a fund consistently underperforms compared to its peers, it may not be performing along expected lines.
Evaluate the fund’s performance against the appropriate benchmark
Every mutual fund is benchmarked against a specific market index (such as NIFTY 50, BSE Sensex etc). Check whether the mutual fund has outperformed or underperformed its benchmark over different periods. If a fund consistently lags behind its benchmark, it may indicate weak management or suboptimal investment strategies.
Analyse risk-adjusted returns
Risk-adjusted returns measure how much return the fund generates for the level of risk taken. Metrics like the Sharpe ratio, Sortino ratio and alpha help assess the risk-adjusted performance. For example, a high Sharpe ratio indicates better returns per unit of risk taken.
Examine the fund manager’s track record
A fund manager’s expertise and decision-making skills play a crucial role in performance. Check the fund manager’s history, experience and performance with other funds they have managed. If a fund’s performance changed significantly after a new manager took over, it’s worth analysing their track record.
Look at expense ratios and other fees
Mutual funds charge an expense ratio, which covers fund management fees and administrative costs. A high expense ratio can eat into your net returns over time. Compare expense ratios of similar funds to ensure you are not overpaying for fund management.
Monitor portfolio composition and asset allocation
Check the proportion in which the fund is investing in stocks, bonds or other assets and whether it aligns with the scheme’s stated objectives and your risk tolerance. Look for sectoral biases or over-concentration in certain industries that might increase risk.
Read Also: What are mutual fund units?
Tools and resources to track mutual fund performance
As an investor, you have access to a wide range of resources. For instance:
- AMC websites: AMC websites typically update the NAVs of their schemes on every business day. For schemes that have completed more than a year, they may also list returns across time periods and comparisons with relevant benchmarks.
- Financial portals and apps: Several fintech platforms and other financial websites help you compare schemes across fund houses and track the performance of various funds. Some may also offer an analysis of a fund’s portfolio and risk-adjusted return metrics.
- AMFI website: The Association of Mutual Funds in India has multi-year performance information for all schemes.
- SEBI-mandated disclosures: Documents like product factsheets, Key Information Memorandums (KIMs) and monthly/quarterly reports can also be looked at for information.
- Online calculators: Online calculators such as CAGR calculators, SIP calculators and others can be a useful tool to help evaluate a fund performance against your financial goals.
Why should investors evaluate the performance of a mutual fund?
- To assess alignment with financial goals: If a fund is consistently underperforming the market and its peers, you may need to switch to a better-performing one so that you can potentially meet your financial goals.
- Identifies underperforming funds: You can avoid losses by exiting funds that consistently underperform.
- Optimises returns: Reviewing your investments helps you optimise return potential by reallocating funds to better-performing options.
- Manages risks: If a fund becomes too risky, you can shift to one with better risk-adjusted return potential.
- Keeps you updated on market changes: Market conditions change frequently, and reviewing your portfolio helps you stay informed.
Common mistakes to avoid when checking mutual fund performance
There are a few common mistakes that investors may make when checking the performance of a mutual fund. These include:
- Focusing only on short-term returns without considering the fund’s long-term track record or performance over different market conditions*.
- Underestimating the impact of risks and volatility when evaluating a mutual fund’s suitability for their goals.
- Relying on incomplete sources and not checking fund-related information in official documents.
- Overlooking key factors such as the expense ratio, risk-adjusted return metrics, and portfolio details.
By avoiding these mistakes, investors can ensure a more balanced and informed evaluation of their mutual fund investments.
*Past performance may or may not be sustained in future.
Conclusion
Evaluating mutual fund performance is an important aspect of successful investing. By analysing historical returns, comparing with benchmarks, checking expense ratios and reviewing risk-adjusted returns, you can make better investment decisions. Regularly monitoring your mutual fund investments can help them stay aligned with your financial goals and risk appetite.
FAQs:
What key metrics should I use to evaluate mutual fund performance?
You should look at historical returns, benchmark comparison, risk-adjusted returns (Sharpe ratio, alpha), expense ratio, and fund manager track record.
How can I compare the performance of different mutual funds?
- Compare funds with similar investment objectives and categories.
- Compare returns with the benchmark to assess if the fund is outperforming or underperforming the market.
- Check metrics like Sharpe ratio and Alpha for risk-adjusted performance.
How often should I review my mutual fund’s performance?
It is recommended to review your mutual fund performance at least once every 6 months. Major life changes, market fluctuations or fund manager changes may require more frequent reviews. If a fund consistently underperforms, consider switching to a better-performing one.
How does the expense ratio affect mutual fund performance?
The expense ratio is the annual cost that is charged by the fund house to manage a particular fund. A higher expense ratio reduces the net returns, while a lower expense ratio allows investors to retain more of their returns.
Can short-term market fluctuations affect mutual fund evaluation?
Yes, the value of a mutual fund depends on the market value of the securities in its portfolio, so it can be affected by market conditions in the short term as well as the long term. However, volatility tends to be higher in the short term and markets may recover over time.
What role does the fund manager play in performance?
A fund manager is responsible for managing the fund’s portfolio and making key investment decisions (while adhering to regulatory guidelines). Their investment strategy and track record are important factors to review before investing.
How to check the benchmark of a mutual fund?
The benchmark of a fund is mentioned in the Scheme Information Document (SID) and in the fund’s factsheet. Both are typically available on the mutual fund company’s website.
Is past performance an indicator of future returns?
No, past performance cannot be used as an indicator of future returns. The fund’s performance depends on various factors such as market conditions, economic trends, and fund management strategies, which can change over time. Past performance may or not be sustained in future.
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