How to compare mutual funds

Choosing a mutual fund seems to have become a very complex affair lately.

There are no dearth of funds in the market and they all claimer for attention.

The most crucial factor in determining which one is better than the rest is to look at returns. Returns are the easiest to measure and compare across funds.

At the most trivial level, the return that a fund gives over a given period is just the percentage difference between the starting Net Asset Value (price of unit of a fund) and the ending Net Asset Value.

Returns by themselves don't serve much purpose. The purpose of calculating returns is to make a comparison. Either between different funds or time periods. And, you must be careful not to make a mistake here. Or else, you could end up investing in the wrong funds.

Invest in various funds, not one

Absolute returns

Absolute returns measure how much a fund has gained over a certain period. So you look at the NAV on one day and look at it, say, six months or one year or two years later. The percentage difference will tell you the return over this time frame.

But when using this parameter to compare one fund with another, make sure that you compare the right fund. To use the age-old analogy, don't compare apples with oranges.

So if you are looking at the returns of a diversified equity fund (one that invests in different companies of various sectors), compare it with other diversified equity funds. Don't compare it with a sector fund which invests only in companies of a particular sector.

Don't even compare it with a balanced fund (one that invests in equity and fixed return instruments).

Why has my fund not declared a dividend?

Benchmark returns

This will give you a standard by which to make the comparison. It basically indicates what the fund has earned as against what it should have earned.

A fund's benchmark is an index that is chosen by a fund company to serve as a standard for its returns. The market watchdog, the Securities and Exchange Board of India, has made it mandatory for funds to declare a benchmark index.

In effect, the fund is saying that the benchmark's returns are its target and a fund should be deemed to have done well if it manages to beat the benchmark.

Let's say the fund is a diversified equity fund that has benchmarked itself against the Sensex.

So the returns of this fund will be compared vis-a-viz the Sensex.

Now if the markets are doing fabulously well and the Sensex keeps climbing upwards steadily, then anything less than fabulous returns from the fund would actually be a disappointment.

If the Sensex rises by 10% over two months and the fund's NAV rises by 12%, it is said to have outperformed its benchmark. If the NAV rose by just 8%, it is said to have underperformed the benchmark.

But if the Sensex drops by 10% over a period of two months and during that time, the fund's NAV drops by only 6%, then the fund is said to have outperformed the benchmark.

A fund's returns compared to its benchmark are called its benchmark returns.

At the current high point in the stock market, almost every equity fund has done extremely well but many of them have negative benchmark returns, indicating that their performance is just a side-effect of the markets' rise rather than some brilliant work by the fund manager.

The best mutual fund scheme for you

Time period

The most important thing while measuring or comparing returns is to choose an appropriate time period.

The time period over which returns should be compared and evaluated has to be the same over which that fund type is meant to be invested in.

If you are comparing equity funds then you must use three to five year returns. But this is not the case of every other fund.

For instance, cash funds are known as ultra short-term bond funds or liquid funds that invest in fixed return instruments of very short maturities. Their main aim is to preserve the principal and earn a modest return. So the money you invest will eventually be returned to you with a little something added.

Investors invest in these funds for a very short time frame of around a few months. So it is alright to compare these funds on the basis of their six month returns.

To understand these funds, read Tired of your savings account? Try this.

Market conditions

It is also important to see whether a fund's return history is long enough for it to have seen all kinds of market conditions.

For example, at this point of time, there are equity funds that were launched one to two years ago and have done very well. However, such funds have never seen a sustained declining market (bear market). So it is a little misleading to look at their rate of return since launch and compare that to other funds that have had to face bad markets.

If a fund has proved its mettle in a bear market and has not dipped as much as its benchmark, then the fund manager deserves a pat on the back.

Why you should watch over your mutual fund

Final checklist

Here are some quick pointers when comparing funds.

-Compare funds that are similar. For instance, compare Alliance Equity with Franklin India Prima. Both are diversified equity funds. Similarly, compare UTI Auto with J M Auto, both being auto sector funds. Or Birla Midcap with Magnum Midcap, both being funds that invest in mid-cap companies.

Don't compare the performance of Alliance Equity with UTI Auto or even Alliance Equity with Birla Midcap.

- When returns are compared, make sure that the time period is identical. Or else, you may be looking at the one-year returns for one fund and the three-year returns for another.

For instance, if you were told that the return of HDFC Equity was 59.72% and that of Franklin India Prima was 61.74%, it would be misleading.

Because the return stated of HDFC Equity is a one year return while that of Franklin India Prima is the three-year return.

- Compare a fund with it's own stated benchmark, not another. For instance, Fidelity Equity, Escorts Growth and BoB Growth are all diversified equity funds with different benchmarks.

Fidelity Equity - BSE 200

Escorts Growth - S&P CNX Nifty

BoB Growth – Sensex

While there are other factors that have to be considered when investing in a mutual fund, returns is the most important. So make sure you do your homework right on this count.

Links for Top Rated Funds  

https://www.valueresearchonline.com/toprated.asp?star=5%2C4

http://www.moneycontrol.com/mutual-funds/top-rated-funds#ELSS

https://www.fundsupermart.co.in/main/fundinfo/topFunds.svdo?actionPerformed=topFunds

Different types of Debt Mutual Funds

There are different types of Debt Mutual Funds that invest in various fixed income securities of different time horizons. Some of the debt based & blended category products (which have both debt and equity allocation) are as follows -

Liquid Funds / Money Market Funds

These funds invest in highly liquid money market instruments and provide easy liquidity. The period of investment in these funds could be as short as a day. They aim to earn money market rates and could serve as an alternative to corporate and individual investors, for parking their surplus cash for short periods. Returns on these funds tend to fluctuate less when compared with other funds.

Ultra Short Term Funds

Earlier known as Liquid Plus Funds, they invest in very short term debt securities with a small portion in longer term debt securities. Most ultra short term funds do not invest in securities with a residual maturity of more than 1 year. Also referred to as Cash or Treasury Management Funds, Ultra Short Term Funds are preferred by investors who are willing to marginally increase their risk with an aim to earn commensurate returns. Investors who have short term surplus for a time period of approximately 1 to 9 months should consider these funds.

Floating Rate Funds

These funds primarily invest in floating rate debt securities, where the interest paid changes in line with the changing interest rate scenario in the debt markets. The periodic interest rate of the securities held by these products is reset with reference to a market benchmark. This makes these funds suitable for investments when interest rates in the markets are increasing.

Short Term & Medium Term Income Funds

These funds invest predominantly in debt securities with a maturity of upto 3 years in comparison to a Regular Income Fund. These funds tend to have a average maturity that is longer than Liquid and Ultra Short Term Funds but shorter than pure Income Funds. These funds tend to perform when short term interest rates are high and could potentially benefit from capital gains as liquidity comes back to the market and interest rates go down. These funds are suitable for conservative investors who have low to moderate risk taking appetite and an investment horizon of 9 to 12 months.

Income Funds, Gilt Funds and other dynamically managed debt funds

These funds comprise of investments made in a basket of debt instruments of various maturities & issuers. These funds are suitable for investors who willing to take a relatively higher risk as compared to corporate bond funds,and have longer investment horizon. These funds tend to work when entry and exit are timed properly; investors can consider entering these funds when interest rates have moved up significantly to benefit from higher accrual and when the outlook is that interest rates would decrease. As interest rates go down, investors can potentially benefit from capital gains as well. A few types of dynamically managed debt funds are mentioned below -

·         Income funds invest in corporate bonds, government bonds and money market instruments. However,they are highly vulnerable to the changes in interest rates and are suitable for investors who have a long term investment horizon and higher risk taking ability. Entry and exit from these funds needs to be timed appropriately. The correct time to invest in these funds is when the market view is that interest rates have touched their peak and are poised to reduce.

·         Gilt Funds invest in government securities of medium and long term maturities issued by central and state governments. These funds do not have the risk of default since the issuer of the instruments is the government. Net Asset Values (NAVs) of the schemes fluctuate due to change in interest rates and other economic factors. These funds have a high degree of interest rate risk, depending on their maturity profile. The higher the maturity profile of the instrument, higher the interest rate risk.

·         Dynamic Bond Funds invest in debt securities of different maturity profiles. These funds are actively managed and the portfolio varies dynamically according to the interest rate view of the fund managers. These funds Invest across all classes of debt and money market instruments with no cap or floor on maturity, duration or instrument type concentration.

Corporate Bond Funds

These funds invest predominantly in corporate bonds and debentures of varying maturities that offer relatively higher interest, and are exposed to higher volatility and credit risk. They seek to provide regular income and growth and are suitable for investors with a moderate risk appetite with a medium to long term investment horizon.

Close Ended Debt Funds

·         Fixed Maturity Plans (FMPs) are closed ended Debt Mutual Funds that invest in debt instruments with a specific date of maturity that is less than or equal to the maturity date of the scheme. Securities are redeemed on or before maturity and proceeds are paid to the investors. 

FMPs are similar to passive debt funds, where the portfolio manager buys and holds the debt securities for the entire duration of the product. FMPs are a good option for conservative investors, as they do not carry any interest rate risk provided the investor stays invested until the maturity of the product. They are also a tax efficient investment option.

Hybrid Funds

They bridge the gap between equity and debt schemes by investing in a mix of equity and debt securities. This adds a considerable amount of risk to the product and will suit investors looking for commensurate returns with higher levels of risk than regular debt funds.

Debt Mutual Funds

Debt Mutual Funds mainly invest in a mix of debt or fixed income securities such as Treasury Bills, Government Securities, Corporate Bonds, Money Market instruments and other debt securities of different time horizons. Generally, debt securities have a fixed maturity date & pay a fixed rate of interest.

Debt funds offer several advantages but small investors know little about them. Here's how you can benefit from them.

1. Tax rules have changed

In this year's Budget, the tax rules for debt funds were changed. The minimum tenure for long-term capital gains was extended from one to three years. This means that investors will have to remain invested for at least three years if they want the benefit of lower tax on long-term capital gains.

If redeemed within three years, the gains will be added to the person's income and taxed as per the applicable income tax slab. However, if the investor can hold for more than three years, a debt fund will be far more tax-efficient than a fixed deposit. In a fixed deposit, the entire interest earned is taxed at the rate applicable to the investor. The long-term capital gains from debt funds are taxed at 20% after indexation. 

Indexation takes into account inflation during the period that the investment is held by investor and accordingly adjusts the buying price. This can lower the capital gains tax significantly.

2. No tax deduction at source

Another tax-friendly feature of debt funds is that there is no tax deduction at source (TDS) on the gains. In fixed deposits, if your interest income exceeds Rs 10,000 a year, the bank will deduct 10.3% from this income. If you are not liable to pay tax, you will have to submit either Form 15H or 15G to escape TDS. The other problem is that the income from fixed deposits is taxed on an annual basis. 

You will get the money once the deposit matures, but the income is taxed every year. In debt funds, the tax is deferred indefinitely till the investor redeems his units. What's more, the gains from a debt fund can be set off against short-term and long-term capital losses you may have suffered in other investments. 

3. Returns are market-linked

Though they are looking very promising, debt funds do not offer assured returns. In fact, they can also churn out losses in case the interest rates go up, although the possibility of this happening is remote. The maturity profile of the holdings defines the volatility of a debt fund. Funds holding short-term bonds are not very volatile and give returns roughly equivalent to the prevailing interest rate. 

But the funds that invest in long-term bonds are more sensitive to changes in interest rates. If rates decline, the value of bonds in their portfolio shoots up, leading to capital gains for the investor. While the average short-term debt fund has given 9.8% returns in the past year, some long-term bond funds have shot up by 14-15% during the same period. 

4. Invest in SIPs via debt fund

Financial planners say one should not invest a large sum in stocks at one go. Instead, SIPs are the best way to buy equity funds. If you have a large sum to invest, put it in a debt fund and start a systematic transfer plan to the equity fund of your choice. Every month, a fixed sum will flow out from the debt fund into the equity scheme.

Compared to the 4% your money would have earned in the savings bank account, it has the potential to earn 9-10% in the debt fund. Similarly, if you want regular retirement income from your investments, invest in a debt fund and start a systematic withdrawal plan. Every month a fixed sum will be redeemed from your investment.

5. Keep in mind the exit load

A debt fund is very liquid since you can withdraw your investments at any time and the money is in your bank account within a day. However, some funds levy a penalty for exiting before the minimum period. The exit load can vary from 0.5% to 2%, while the minimum period can range from six months to up to two years. Check the exit load of the fund before you invest. Even a 1% exit load can shave off a significant portion from your gains. 

Benefits of investing in Debt Mutual Funds

The various benefits of investing in Debt Mutual Funds are listed below -

Your investments are not affected by equity market volatility

Debt Mutual Funds invest in a range of interest bearing instruments such as Treasury Bills, Government Securities, Corporate Bonds, Money Market Instruments and other debt securities.

Add stability to your investment portfolio

As Debt Mutual Funds mainly invest in debt securities, they are relatively more stable than equity investments. They can also lend stability to your equity portfolio by reducing the risk associated with your complete investment portfolio.

Freedom to withdraw your money when required

All open ended mutual funds give you the freedom to withdraw your money as and when required, although your investments may be subject to an exit load. Close ended mutual funds have a defined maturity date. Such funds are listed and can be traded on the stock exchange.

You can aim for better post tax returns

Earnings from debt instruments can come in two forms:

·         Dividend or interest payments

·         Capital gains based on the difference between the purchase price and the sale price of the debt security

Tax on dividend / interest income : Dividend distribution Tax (DDT) is broken up into the following

·         Dividend for individual v/s non-individual investors and

·         Dividend from liquid v/s non-liquid funds

Index Mutual Funds

Index Funds today are a source of investment for investors looking at a long term, less risky form of investment. The success of index funds depends on their low volatility and therefore the choice of the index.

Index funds are a relatively small part of the overall mutual fund industry in India,

there are two aspects to this,  the first is that  Actively managed funds have performed better than index funds in the past and people expect that to continue in the future as well, and secondly, index funds aren’t really low cost in India.

The two main benefits of investing in index funds – which is low costs and doing better than active funds have been more or less absent in India so far and it’s hard to say why. People who want the benefit of passive investing feel that by creating a SIP in an active mutual fund – you enjoy the same kind of benefit and the past returns show that it has been beneficial as well.

CRISIL Mutual Fund Ranking List

EQUITY LINKED SAVINGS SCHEMES (ELSS)

An Equity Linked Savings Scheme (ELSS) is an open-ended Equity Mutual Fund that doesn't just help you save tax, but also gives you an opportunity to grow your money.

Equity-linked saving schemes are among the options that are eligible for tax benefits under Section 80C. Here are some facts that will help you make better investment decisions.

1) What are the tax benefits?

Up to Rs 1.5 lakh invested in ELSS funds in a year is eligible for deduction under Section 80C. (FY 2014-2015 & 2015-2016) However, unlike the life insurance policies, you cannot invest on behalf of a minor and avail of tax deduction. No tax is levied when you redeem your investment after the lock-in period.

Since ELSS funds have more than 65% of their corpus invested in stocks, they enjoy the exemption from tax on long-term capital gains as is the case with any other equity fund. The dividend income is also tax-free.

arameter	PPF	NSC	ELSS
Tenure	15 years	6 years	3 years
Returns	(Compounded Annually) 8.80 % ^	(Compounded half-yearly) 8.60 to 8.90 % ^	Not assured dividends/ returns
Minimum investments	Rs.500	Rs.100	Rs.500
Maximum investments	Rs.1,50,000	No limit*	No limit*
Amount eligible for deduction under Section 80C	Rs.1,50,000	Rs 1,50,000	Rs 1,50,000
Taxation for interest	Tax free	Taxable	Dividends and capital gain tax free
Safety/ Rating	Highest	Highest	High Risk

* There is no upper limit on investments. However, investments of only up to Rs.1,50,000 per year are allowed to be claimed as deductions under Section 80C of IT Act.

2) Will you get assured returns?

Since these are essentially diversified mutual funds, there is no guarantee on returns. The ELSS category has given an average return of 11.2% in the past five years. The best performing fund return of 11.2%  during this period, but the worst performing scheme reduced it to 4.2%.

Apart from the performance of the broader market, your returns are dependent on the fund manager's ability to pick the right stocks. This also means you must select the fund after proper research. Instead of picking a fund with high, but volatile, returns, choose one with a stable performance record.

3) What's the lock-in period?

The lock-in period is only three years, the shortest among all tax-saving options under Section 80C. You cannot redeem or switch to another option during this period. In the case of SIPs, each instalment is treated as a separate investment and will have a three-year lock-in period. So, if you started investing in an ELSS fund in April 2012, you can redeem the units bought in the first instalment only in April this year.

The lock-in stipulation does not mean that the investor must compulsorily redeem the funds after three years. Unlike Ulips and pension plans, there is no maturity date of an ELSS fund. If you want, you can remain invested for a longer period.

4) Dividend, growth or reinvestment?

The dividend is only a profit-booking exercise since a fund's NAV reduces by the amount the investor receives as dividend. In the growth option, the amount remains invested for the entire tenure.

The dividend option provides a periodic income to the investor, though there is no obligation on the part of the mutual fund to declare a dividend or maintain its pay-out ratio year after year. The growth option has the potential to generate higher returns. Your choice should depend on your needs and risk appetite. Avoid the dividend reinvestment option because you will find it difficult to exit the fund completely. There will always be some units that have not completed the lock-in period.

5) How should you invest?

Unlike regular equity schemes, the ELSS funds have a lower investment threshold of Rs 500. You can invest a large amount at one go, but the best way to invest in equity-oriented instruments is through regular monthly driblets called SIPs.

Thematic – Infrastructure

Infrastructure funds are part of a mutual fund category called thematic funds.

Infrastructure mutual funds are those which invests in stocks that either directly or indirectly involved in Infrastructure development. Companies which are into Energy, Real Estate, Power, Metal etc. would fall under Infrastructure sector. Companies like Banking, Finance, Transportation, etc. would contribute indirectly to Infrastructure development. Infrastructure mutual funds would invest in all these stocks.

While Sectoral funds invest in particular sectors like, say, information technology, power, metals, oil and gas, etc., thematic funds invests in themes like infrastructure, consumption-led categories like the retail industry and outsourcing companies.

Infrastructure, as a theme, covers several sectors like power utilities, power equipment and construction companies. Unlike technology sector mutual funds infrastructure funds are not restricted to a few sectors.

From a risk point of view, a thematic fund carries less risk than a sectoral fund. The reason being, it’s focused on only two to three sectors. If these sectors do well, so will the fund. But, if these sectors suffer, the fund will suffer too as it lacks diversification. Since thematic funds have a little more diversification they are less risky than sectoral funds.

Diversified Equity Mutual Funds

Diversified Equity funds are those that spread their investments across sectors e.g IT, Pharma, Banking, Oil & Gas, Real estate, Telecom, FMCG, etc. So they are not restricted to one specific sector. They diversify their allocations across sectors and thus minimise the risk of over-concentration in any one particular sector. Over the long term, diversified equity funds have had the best track records.

How to go about - making your money work best for you:-)

There is nothing like starting early, in your investing life and use the power of compounding to your advantage.

Next, you can invest in a mix of the following strategies, depending on your investing risk profile, as indicated below. Invest only those funds that you do not need. Use these funds to invest wisely. You need to remain invested for the long term, since you want capital growth.

Conservative Risk Profile (you seem to be of this type; someone who wants his principle to be secure and is looking for a decent growth over the long term)

It is plain wisdom that to invest in a diversified equity fund, you need to pick the right one that suits your requirement the best. In reality it is easier said than done. When there are more than hundred equity funds claiming best returns in their schemes, it is quite puzzling to zero in on one. And the self-seeking mutual fund agents who survive only by cooking the figures further confound the problem.

To cut through the confusion, you need to have a set of objective factors serving as parameters while selecting the right diversified equity fund. What matters is the performance of a diversified equity fund against all the parameters.

The fundamental thing to remember is that not just one factor makes a diversified equity fund worthy enough to be a part of well-performing mutual fund portfolio. An ideal diversified equity fund must pass all these 6 parameters.

1. Match your investment objective with that of the diversified equity fund

First things first. It is of utmost importance that your investment objective is in tune with the diversified equity fund’s investment objective.

2. Evaluate returns across diversified equity funds within the same class

To compare diversified equity funds within the similar category is one of the essentials for benchmarking a fund. When evaluating a large cap diversified equity fund for investment, you must compare its yield with other matching large cap diversified equity funds.

Comparing it with mid cap diversified equity funds won’t give you the real picture as the risk-reward relationship between both is too wide to compare.

Another factor in evaluating a diversified equity fund is timeframe. Diversified equity funds are designed to deliver returns over long period of years; you should invest in diversified equity funds with a foresight.

Evaluating a diversified equity fund over a longer timeframe helps you gauge its performance during boom and bust periods. You can observe the consistency of the returns of a diversified equity fund by its performance during different market phases combined with the category average.

3. Check diversified equity fund returns against the benchmark index

It is mandatory for every diversified equity fund to mention a benchmark index in its offer document. This benchmark index is the signpost to judge if the diversified equity fund has fared well.

While evaluating the performance of a diversified equity fund against its benchmark index, you should take into account the longer time period. Those diversified equity funds that outperform their benchmark indices constantly are best suited for investment.

In India, most diversified equity funds do better than their benchmark indices over long timeframe. But during choppy times you may find many diversified equity funds lagging behind their benchmark indices. Those diversified equity funds that stay ahead of their benchmark indices during rough times must be earmarked.

4. Evaluate the consistency of the diversified equity fund

Apart from peers and benchmark index evaluation, a diversified equity fund must be judged by its historical performance. Many diversified equity funds don’t stay stable over the years, they take a dip during recessions and sometimes even dip below their benchmark indices and category average.

Only a handful diversified equity funds perform strongly against all odds and display steady performance. Those warriors who brave rough times and display stability are the ones to add to your portfolio.

5. Check the costs associated with the diversified equity fund scheme

Besides performance analysis, you must consider the costs involved with making investment in that particular diversified equity fund scheme as this affects your net returns from that scheme.

Before you make the final decision of investing in a diversified equity fund, you must check its expense ratio. Along with that you should also know the exit load (charges levied by a mutual fund scheme when redeeming within the stipulated period) while asking for redemption from a diversified equity fund scheme.

6. Risk-return analysis of diversified equity funds

To evaluate the performance of a diversified equity fund, it is common to look at its absolute returns. However, that is not enough as diversified equity funds being market-linked are susceptible to stock related risks. Hence, you should not only assess a diversified equity fund on the basis of returns but also take into account the risk involved with the fund.

If you overlook the risk factor, you might lose your hard-earned money. So you must do risk-returns analysis of a diversified equity fund before you invest in it. There are some simple but effective ratios available to be followed:

Alpha: It is a unit of diversified equity fund’s performance on a risk-adjusted basis. Taking the volatility (price risk) of a diversified equity fund, Alpha weighs its risk-adjusted performance to benchmark index. The ratio of excess return of the diversified equity fund to the return of the benchmark is the fund’s Alpha.

Beta: It is also known as the Beta coefficient and calculates the volatility of a diversified equity fund scheme in relation with its benchmark index. You can consider Beta as the tendency of your diversified equity fund’s ability to react to fluctuations in the market or its benchmark index.

If the above two ratios are taken together, it makes apparent that those diversified equity funds that generate high Alpha albeit at lower (less than1) Beta are worthy of investment.

Standard deviation (SD): This is a measurement of the volatility of returns. To get SD, you need to calculate the average returns yielded by the diversified equity fund for a fixed period and then measure the deviation from the mean.

Higher the deviation, greater the standard deviation denoting a highly volatile fund. If you want to avoid high risk, you should choose diversified equity funds with lower SD.

Final note:

Now that you know what to look for in a diversified equity fund, you can pick the right one that meets your investment needs. Keep your eyes open and make an informed decision before you invest.