How to eval­u­ate if your mu­tual fund is giv­ing ad­e­quate re­turns

Mint Asia ST - - Otherviews - BSY UNITA A BRAHAM


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.

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