Dubai: If you’re new to investing in mutual funds, one of the key challenges you will face initially is the surfeit of choice available to you. However, there are a few indicators that can help you narrow down your choices and find the one most suitable to you and offers least risk to your investments.
“A ‘winning’ investment is one that provides long-term gains for its investors, but finding the right investment among numerous choices often gets complicated as profitability will mean different things to many investors,” said Zubair Shakeel, a wealth and investment advisor based in Dubai.
“With over 130,000 mutual funds on offer worldwide, it’s vital to know how to pick a ‘winning’ mutual fund and create a portfolio of such mutual funds. It’s not impossible as there are indicators and track records advertised by mutual funds to help you filter through to a fund that wins you big.”
Selecting a mutual fund is a two-step process
In order to choose the right mutual fund, the key to separating good funds from the not-so-great ones is to get to first take a look at the fund’s printed prospectus or online profile. Know that no one mutual fund is suitable for all because financial goals and appetite for risk varies with each person.
“Selecting a mutual fund is a two-step process. The first is identifying a goal you aim to accomplish with the investment. It can be any short-term or long-term financial aspiration – buying a house or car, financing children’s higher education, going on a vacation, retirement, etc.,” added Shakeel.
“The next step is deciding how long you wish to keep the money invested and manage all other costs without it. It can be either as short as 1 day or as long as more than 5 years. But know that market can be highly volatile in the short term but tends to provide higher earnings growth over time.”
Key metrics to track mutual fund performances
A benchmark index of a mutual fund is simply a standard against which its performance is compared. In other words, the benchmark index is a guide that matches the composition of investments made by the mutual fund you are considering.
“The benchmark index of a mutual fund that invests majority money in shares of high-value companies, should be an index of similar high-value stocks. Similarly, the benchmark of a mutual fund focussed on banking stocks should be an index of banking stocks,” explained Shakeel.
An important gauge to selecting a mutual fund scheme is checking the fund’s performance in comparison to its peers. This is a bit of information made available by most mutual funds and helps in getting a better understanding of how the fund is performing compared to others like it.
“When comparing a mutual fund’s performance against a ‘Category’, it’s with similar funds. For instance, a large-cap mutual fund investing in high-value firms can only be compared with other large cap mutual funds and not against mid-cap funds investing in mid-value firms,” Shakeel added.
A mutual fund should be able to generate returns for its investors consistently over a period of time and not just earn you starkly-varying returns. “A mutual fund should be able to provide consistent returns in all periods of the stock market,” said Brody Dunn, another UAE-based investment manager.
“When selecting a mutual fund, also locate the performance of its fund manager and how long he or she has managed the fund. For this, you can look at the manager’s experience with the funds managed by him or her. The information is mandatorily required to be provided by the fund house.”
4) AMC Track Record
An Asset Management Company (AMC), also known as fund house, is the company which manages a mutual fund scheme. “Many decisions are made by the AMC as to which stocks need to be invested in. So check the track record of an AMC while selecting a mutual fund scheme,” Dunn added.
“Websites of various AMCs allow you to get all the information regarding a mutual fund. Apart from this, you can also visit the official website or mobile application of the concerned broker or mutual fund distributor to get all the details.”
5) Assets Under Management (AUM)
The AUM of a mutual fund refers to the value of investments it manages. In other words, AUM gives an idea of how many investors have subscribed to the fund. The top-performing mutual funds globally tend to attract more investors and grow bigger in size and AUM.
“When more people invest or exit the fund and when the mutual fund’s investments rise or fall in market value, the AUM can rise or fall. Larger sizes of AUM is favourable in case of short term funds as it makes the fund less vulnerable to redemptions made by large investors,” Dunn noted.
6) Expense Ratio
The expense ratio of a fund reflects the fee charged by an AMC for managing, promoting and distributing funds of a mutual fund. All expenses incurred in the running of the fund are included in this figure, which is again compulsorily given when you check details of the fund you’re considering.
“’Direct plans’ of mutual fund schemes have lower expense ratio than the ‘regular plans’ because no distribution commission is paid in the case of direct plans. In general, lower the expense ratio, the higher are the net returns of a mutual fund scheme,” explained Dunn.
Difference between direct and regular plans of a mutual fund
In a ‘direct plan’ offered by the mutual fund, an investor has to invest in a plan directly controlled by the AMC. However, in a ‘regular plan’, the investor invests through an intermediary, such as broker or banker who is paid a distribution fee by the AMC, which is charged to the plan.
Although mutual funds are a preferred choice among investors today owing to their attractive returns and how diversified it inherently is, when it comes to investing, it’s common for people to anchor their mutual fund’s performance to the market.
Let’s say you have 40 per cent of your money invested in a mutual fund, but the market generated a 30 per cent gain , and this makes you feel bad about their measly, let’s say, 18 per cent return on your mutual fund.
This is primarily why mutual fund managers make the above-mentioned metrics available so that it can help you decide which fund has a better history or performance and invest accordingly. But there is also a downside to weighing such information, at least when you over analyse.
“Studying performance metrics of mutual funds before investing may even prompt investors to change their portfolio and take on more risk than they need to,” added Shakeel. “While that’s not necessarily bad for super-safe investors, it may be bad to invest too much in too risky assets.
“So what’s the solution? Create a written investment plan tailored to your age and risk tolerance, including a realistic assumed average annual rate of return, such as 7 per cent. Using that as your anchor, an 18 per cent return wouldn’t be a disappointment; it would be amazing.”