The reason for retail investors flocking to subscribe to mutual fund schemes is that many of the mutual fund schemes have done exceedingly well and rewarded their investors handsomely over the years. But there are also many schemes that have underperformed and disappointed th investors. So, how does one assess the performance of a MF scheme and pick out a winner? Here a few parameters on which the performance of a MF scheme has to be evaluated:
Returns: The returns on investment is the most crucial parameter for any mutual fund scheme. The returns have to be consistent across different periods of time, that is, one year, three years and five years. A scheme that has performed well in the short term may have underperformed over a longer term, so it is important that the scheme should do well across multiple periods. Also, the returns of a MF scheme have to be consistently better than similar other schemes as well the benchmark index over different market cycles as these will test the investment acumen and portfolio management skills and experience of the fund manager. In a rising market, even an average fund manager will deliver good returns, but his fund management skills will be put to real test when the markets are going downhill.
Risk-adjusted returns: The risk-adjusted return is a tool to refine the return on an investment by calculating the amount of risk involved in generating the expected or realised return. Some of the risk measures include alpha, beta, R-squared, standard deviation and Sharpe ratio. The higher the value of Sharpe ratio, the greater the risk-adjusted return. Such technical calculations may not be the cup of tea for some of the investors, but some such number crunching is inevitable if the returns are to be maximised.
Portfolio creation and management: The skills of the fund manager is put to test while creating a portfolio that is in line with the goals of the investors and generates excellent returns over the investment time frame. If the composition of the portfolio does not match up to the goals or if the scheme underperforms the benchmark indices in terms of returns generated, the portfolio building and management skills of the fund manager may be called into question.
Cost of management: If the cost, which is the total expense ratio (TER), of managing the portfolio of a mutual fund scheme is too high due to constant churning of the portfolio, the returns on investment are likely to get adversely impacted. Hence, one can bet on a fund manager who keeps the TER well below the stipulated limit and generates excellent returns over the long term.