Most of the people look at past two or three years of mutual fund track record to select best mutual fund and call this an analysis but past is not always the answer for the future.
Theories most of the people use.
- Relying on Mutual Fund dealer’s recommendations.
They only tend to sell you those mutual funds which gives them highest commission irrespective of their merit to investors who pay them fees.
- Buy fund that has given highest return (abnormally high).
Sometimes luck works in market so bad mutual funds can give good returns in bull markets.
- Buy mutual fund that has worst record because reversion to the mean will show its magic and fund will outperform index.
There is no guarantee that this will happen every time with each under performing mutual fund.
Sure very deep analysis won’t help much to get unprecedented returns like 40-50 percent per annum. But it is recommended for investors to do little research in order to avoid buying piece of crap.
In this article I will try to explain how to do quick mutual fund analysis to avoid foolish things.
We overlook this factor because we think 1-2 % do not matter much. But there are two things about fees, first they have to be paid irrespective of loss or gain of investors(yes sometimes you pay to burn your money). Second thing is that if 2 percent fees that we pay every year, if compounded for several year sums up to large number which is opportunity loss which we don’t even realize.
So compare management fees with other similar funds. Say if you are thinking of investing in ICICI bulechip then compare management fees with other bluechip funds available in market. Composition of many of such funds are more or less same but they differ vastly in terms of fees.
Index funds are best in perspective of management fees their fees ranges from 0.2-0.30 % only and they are also proven to have given satisfactory returns.
Managers sometimes unnecessarily churn their portfolio just in order to show they are doing some actions and so they deserve fees. This cost great to investors, because whenever any transactions are made both parties have to pay brokerage fees,(securities transaction tax) STT, different type of CESS, exchange charges etc.
Tips is same compare turnover and results (I will discuss on that bit later) and fund type at same time to get broad range perspective.
Never make mistake to compare index funds with other type of funds because index funds work on completely different theory than active management of equity that is why they are extremely low turnover and extremely low fees.
Social psychology and over optimism drove prices of even worst companies to unprecedented levels but this things cannot go on for forever and when bear takes control only fundamentally strong companies successfully hold their price levels.
So even if funds outperform by wide margin in bull market is not relevant. What really matters how it perform in bad times.
So while looking at past track record always look how fund have performed bear market or recessions.
What we should never expect in results.
- In stock market there are lot of ways (strategies) to make money but there is no way that will outperform all the times. While applying strategies there are favorable times and unfavorable times so returns vary according to that. Thus investor should never expect any fund to outperform indices in all years.
- Many funds have very bad track record no matter market is favorable or not but that doesn’t mean that all funds will cover up their average by outperforming in the future. Because in some funds there are structural deficiencies or fund manager may not be that competent.
No matter how powerful car engine you have if driver is drunken then fate will not be good.
What to look in manager is what are other funds he has managed, milestones achieved, positions served, name of the institutions he worked for, educational qualification, what is his style of management (is he growth investor or value investor).
Lot of institutions and retail investor give great emphasis to credit ratings. I think there is no relation to credit rating and returns.
Were rating agencies successful in identifying liquidity risk of Franklin Templaton debt funds which were shut down because of lot of redemption in covid crisis.
Do you remember any fraud case studies were inconsistencies were brought up by rating agencies.
Was any debt default warned by credit ratings.
Weren’t credit rating agencies failure was one of the major reason for housing market crisis in 2008.
Answer to all this question is NO. Rating agencies in all above cases were very late to react by downgrading credit status.
So do not rely much on credit ratings.
While investing in mutual funds keep expectations to ground do not expect 20-25 returns per year for series of years. Also do not switch funds time to time this is the worst thing investor can do.
Timing funds or market or to riding wave is almost impossible thing in market stick to good things for long period of time is best thing.