How to evaluate if your mutual fund is giving adequate returns
returns from a fund is the primary parameter while evaluating the performance of a mutual fund. But how do you decide if the fund is acceptable on the returns score? This can be answered at three levels.
Are the returns adequate?
At the first level is a personal ‘hurdle rate’ or the minimum return that the investment or portfolio should earn for the investor to be able to reach his goals and it is unique to each investor. Determining the hurdle rate requires balancing between different factors: if you need to accumulate a large corpus within a shorter period and are willing to take the risk, then you will set a higher hurdle rate if you cannot expand your savings. But if you are able to save more to contribute to the goal then you will seek a lower rate of return that is less risky. If your investment horizon is long then the hurdle rate can be low and you may still get to your goals particularly if you are able to assign the required savings to the goal.
A good way to use the hurdle rate would be to filter out investments from the choices available. Once you have a list of investments that at least meet the hurdle rate then you decide how they score on a comparative basis relative to the performance of a benchmark and its peer group to ensure that your money is working as best as it could.
Did they beat the benchmark?
A benchmark’s returns denote the returns from a market it represents for a particular period. They are not actively managed. The BSE Sensex and the Nifty are stock market indices that are examples of widely used benchmarks for equity investments. If you are invested in an actively managed mutual fund where the fund manager takes calls on which stocks and sectors to invest in and in what concentration then you would expect such a fund to beat the returns from the benchmark where no such calls are made. The extent of outperformance will justify the fees that the portfolio managers charge. The points to keep in mind are that the benchmark selected must reflect the portfolio being evaluated for the comparison to be relevant. For example, comparing the performance of a midcap fund against a large cap index is likely to lead to flawed conclusions on the performance.
Did they outperform peers?
Did the fund manager make the best moves in managing your money? You know this when you compare the performance of your investments with other similar funds. While it is unrealistic to expect to be the best performer every time, at least look for a consistent top quartile performer for your portfolio.
Again, ensure that the peer group selected for comparison is relevant. For example, comparing an ultra-short debt fund that invests in short-term debt and money market with a long duration debt fund gives you no data points to evaluate performance.
Run your investments through the return panel test so that you know that your money is on the right path towards your goals.