It’s very hard for a common man to pick the best mutual fund which is the best fit for one’s financial goal and at the same time should be riskless for going into a long-term investment. In this article, we will discuss the top 10 tools, which can be used by a common man to analyze and select the right mutual fund which gives them a good return and fulfill their financial goals.
1.Credit Rating (Debt schemes only)
What it implies: All debt papers in which the fund invests are rated by agencies based on their risk profile. While government securities are completely risk-free, corporate bonds are rated from AAA (highest safety) to D (lowest safety).
How is it determined: To rate a fund, agencies use their own methodology. Ratings are typically included in the fund’s fact sheet.
Implications for investors: A high rating indicates that the fund is less likely to default on its obligations. Because investors seek debt investments to reduce risk, they should avoid schemes that contain an excessive number of low-quality papers.
2.Sharpe Ratio
What it implies: This ratio represents the scheme’s return per unit of total risk.
How is it determined: (Return – risk free return) ÷ standard deviation
Implications for investors: Only compare within categories. greater than the category average According to the Sharpe ratio, the fund manager was able to generate a higher return per unit of total risk.
3.Average Maturity or Maturity Profile (Debt schemes only)
What it implies: Debt funds invest in securities of varying maturities. The maturity profile shows the average maturity of a fund’s debt securities.
How is it determined: This is typically stated on the fund’s fact sheet.
Implications for investors: Long-term paper market prices are more sensitive to changes in interest rates. If interest rates are expected to rise, investors should avoid funds with long maturities. If interest rates are expected to fall, such schemes can provide higher returns.
4.Expense Ratio
What it implies: This ratio represents the fund’s annual expense to the investor. It ranges from 0.1 percent to 3.25 percent (for fixed maturity plans) (for small-sized equity funds).
How is it determined: Total expenses incurred by the fund/average assets under management.
Implications for investors: The lower the expense ratio, the better the investment. Because most debt funds produce comparable gross returns, the expense ratio becomes more important for debt funds. The expense ratios of direct plans are lower, but the direct fund is only for an investor who is capable of managing their investments and has time for that.
5.Portfolio Concentration Ratio
What it implies: This ratio demonstrates where and how much the fund has invested.
How is it determined: This is typically a percentage of the top five stocks or sectors in the fund.
Implications for investors: For diversified funds, the normal range is 30%-40% for the top five stocks and 30%-60% for the top five sectors. Investors seek diversification through mutual funds; any undue concentration in its portfolio undermines this goal.
6.Exit Load
What it implies: This is the fee that a mutual fund charges for leaving a scheme early.
How is it determined: Exit load typically ranges between 0% (for liquid funds) and 1%. (up to 1 year of holding in an equity scheme).
Implications for investors: For short term investors consider schemes with a lower exit load.
7.Standard Deviation
What it implies: This is a measure of the volatility of a fund’s returns, which indicates the risk in the fund’s portfolio.
How is it determined: First, compute the daily return average. Subtract this average from each daily return and square the result. The variance is calculated by taking the sum of all these squared values and dividing it by the number of days. The standard deviation is the square root of the variance.
Implications for investors: The lower the deviation, the better. However, only within categories should it be compared. The range for liquid funds can be as low as 1% and as high as 20%-40% for equity funds.
8.Portfolio Turnover Ratio
What it implies: This ratio reflects how frequently a scheme trades (buys or sells) securities in its portfolio. While it will be low for passively managed funds, it can reach 500 percent for actively managed equity funds.
How is it determined: The total value of securities sold or purchased in the preceding 12 months/average assets under management of the fund
Implications for investors: This ratio must be compared within each category. Active investors should consider schemes with a high turnover ratio, while passive, long-term buy and hold investors should consider schemes with a low turnover ratio.
9.Treynor’s Ratio
What it implies: This ratio represents the scheme’s return per unit market risk, also known as systemic risk.
How is it determined: (Return – risk free return) ÷ beta
Implications for investors: Only compare within categories. greater than the category average Treynor’s ratio indicates that the fund manager generated a higher return per unit of systemic or market risk.
10.Beta
What it implies: It compares the fund’s performance to the market.
How is it determined: The variance of the market index is calculated in the same way that the standard deviation is. To calculate the covariance between the market index and the scheme, first square the difference between the scheme’s and the index’s daily returns. The covariance is calculated by dividing the sum of all these squared values by the number of days. Finally, beta is calculated by dividing the covariance between the market index and the scheme by the market index variance.
Implications for investors: A beta value of one indicates that the fund’s NAV moves in lockstep with the market. A value less than one indicates that the fund is less volatile than the market, while a value greater than one indicates that it is more volatile than the market.