How to Analyse Performance of a Mutual Fund?
There are some attractive mutual funds available for people to choose from and mutual fund performance analysis will help one to make better investment decisions. The past performance of mutual funds may not determine results in the future. However, if you are educated on how to analyze mutual fund performance, and learn what to avoid and what to look out for, you can make smart investment decisions. This will increase the chances of better mutual fund in the future. Let us look at a few important mutual fund performance indicators that will help you make better decisions.
Compare Returns of Mutual Funds
The first thing that you need to consider while analyzing a mutual fund performance is to compare the fund’s returns with an appropriate benchmark. So, if you take a category of mutual fund and want to learn how well it has been performing, you’ll need to compare it with the average returns of funds that belong to the same category.
For instance, you might take a lot at your 401k statement and see that one of your funds has had a large decline in value while the others have not been performing quite well in a given time frame. If you think that you have to remove the declining fund from your portfolio, you need to consider other aspects. Now that you know about the types of mutual funds in India, the wise thing to do would be to check if other funds in the same category are performing the same way. This would help you make better decisions.
You can use an index for a benchmark. For example, let us take the case of a large-cap equity fund. You may compare its performance with a broad-based index like Nifty 500. If the benchmark returns were 12% and your fund returns were a good 15%, it is good to go fund. If the case is the other way around, you may have a reason for worry over the performance of your fund.
How a Good Fund Can Performance Bad
Most of the time, in case you are investing in an equity mutual fund, it is likely that you’ll be holding it for a period of 3 years or more. If this is the case, most of us think that there is hardly any concern for us to take a look at the mutual fund performance at periods that are less than 3 years. But then, you need to know that this does not mean that returns of the first year are irrelevant. You would be surprised to hear that a mutual fund that has incredibly high returns during its first year, compared to other funds in its category could actually be a warning signal.
There are a couple of reasons as to why strong performance could actually be a negative indicator. The first one is that an isolated year of incredibly high returns is quite unusual. Investing isn’t supposed to be exciting, it has to go slow and be steady. You need to know that strong performance is not sustainable. Another reason that you need to stay away from these mutual funds of this kind is that they attract more assets to the fund.
A smaller amount of money is a lot easier to manage compared to larger amounts. The large increase in assets would not help the fund’s prospects for future performance. Many good managers close funds to future investors as they know that they can’t navigate markets easily when there is too much money to manage.
Effect of Economic Cycles on Mutual Funds
Talk to a variety of investment advisors about what time periods should be considered to analyze mutual funds performance. You are likely to get a different answer every time. However, the one common thing everyone will tell you is that short-term mutual fund performance, that is, the performance of the fund less than a year will give you no indication of its future performance. You need to understand that even the best mutual funds out there will have one bad year out of three.
Actively managed funds require fund managers to take calculated risks to exceed their benchmarks. As a result, a year’s poor performance may only indicate that the manager’s bond or stock selections just haven’t had enough time to reach the desired results.
Focus on Past Performance of Mutual Funds
Different fund managers tend to do better in certain different economic environments. For instance, a fund manager might have a certain investment philosophy that leads to very high returns during very poor economic conditions but then when the economic condition is low; the mutual fund’s performance would be relatively poor.
You may be looking at a fund that is performing weakly or strongly now, but we don’t know what could be the case in the next 2 or 3 years. To judge a fund manager’s skills and to analyze the performance of a mutual fund, it is wise to consider different time periods that spread across different economic environments.
For instance, most economic cycles have a duration of 5 to 7 years. Out of these, there is at least one year of recession or where the stock markets responded poorly. So, if the mutual fund that you are analyzing has a five-year return that is higher than other funds in its category, it is most likely a good choice.
Average Duration and Maturity of Mutual Funds
You need to do this while analyzing the performance of debt funds. Average maturity is the period after which the securities that are held by a debt fund will mature. The longer the average maturity is, the higher will be its sensitivity to interest rate movements. Also, this increases the chances of fall in its NAV due to the rise in its interest rates.
A break-even point is a point of no profit or loss. Duration means the period that each underlying security of the debt fund takes to reach a break-even point. So, you can assume that the shorter this duration is, the quicker it will return to your original investment. In this case, you will be able to collect money to reach your goals. Take a look at your investment horizon and make sure that average maturity and duration of the fund are in terms with it. After considering all the factors mentioned above, you can make smart decisions about buying a mutual fund that fits your portfolio.