5 Ways to Measure Mutual Fund Performance

Mutual funds With growing inflation rates, it may sometimes be difficult to meet your financial goals with just a monthly salary or a fixed income. While there are traditional investment options available, such as fixed deposits, recurring deposits, etc., their capability to generate inflation-bearing returns is limited. On the other hand, mutual funds with higher return potential have emerged as a popular choice among investors in recent times.

A mutual fund is a financial instrument that pools money from different investors to purchase stocks, securities, debentures, bonds, as per the theme of the fund, in view to generate returns for its investors. Since it is professionally managed by experts, it is an excellent investment option for individuals with little or no previous exposure to equity or debt investments. Some of the major benefits of mutual fund investment are as below:

• Managed By Experts: Mutual funds are managed by professional experts with extensive knowledge of different financial instruments and hence can better judge the profitability of any particular equity or debt, given the market situations. Moreover, you can start investing while staying away from all the hassles of speculating, buying, and selling.
• Risk Management: Mutual funds manage the risk factor through portfolio diversification, i.e. by including different asset classes in the portfolio depending upon the focus point. There may be highly volatile stocks in your portfolio that can be balanced out by including stocks with high stability or even debt instruments.
• Convenience: It is a convenient way for even beginners to invest. Like traditional FDs, mutual funds are also liquid and can be easily redeemed whenever required, directly with the fund house or through the authorized brokers.

Experts suggest investing in top-performing mutual funds to improve upon chances of higher returns. But the question that arises is how to identify whether a fund is performing well or not. Moreover, how to track the performance of your fund once you have invested. There are below documents that can be referred to estimate the performance of a fund:

• KIM (Key Information Memorandum) It is a document that mentions the information relevant to a prospective investor. You may refer to this document before investing.
• Fund Fact Sheet It is a fact sheet that mentions statistical ratios relevant to the fund's performance and compares it with similar funds in the market. The sheet is uploaded every month and can be downloaded from your AMCs website.

Now let’s look at the measures that can help us evaluate a mutual fund:

1. Alpha: A market benchmark is a set standard used to measure mutual fund performance . Alpha is a financial ratio that reflects the returns generated by the fund over and above the returns generated by the benchmark index. The Alpha value of 0 would indicate that the fund has performed in line with the benchmark. While a negative value would mean it has underperformed as compared to its benchmark index, a figure above 0 would mean that the fund has outperformed. For instance, if a mutual fund generates a return of 15% in a year, whereas the benchmark grows at 12%, the Alpha value, in this case, would be 3. It is generally considered as a measure that represents the value that a fund manager adds or subtracts to a portfolio’s returns.
2. Beta: Beta is another statistical measure calculated using regression analysis, reflecting the volatility of a portfolio compared to the market. It shows the tendency of a portfolio's return to fluctuate as per the market movements. Beta value of 1 indicates that the mutual fund is as volatile as its benchmark. While a value above 1 indicates that the fund is more volatile, a value below represents that the fund reacts lesser than its benchmark.
3. Expense Ratio: The expense ratio is the ratio of the total fund’s expenses to its assets and reflects the per-unit cost of managing a fund. Subtracted from the funds' total earnings before it is distributed to the investors, the expense ratio is inversely proportional to the AUM (Asset Under Management) of the fund. It is an essential factor to be considered while selecting a fund since the higher the expense ratio, the lower is the return and vice versa.
4. Allocations in the Fund’s Portfolio: One of the benefits of investing in mutual funds is the diversification of assets in the portfolio. A well-diversified portfolio is expected to generate better returns since volatile assets are balanced out with stable ones. The fund fact sheet can provide you with the details of the allocated assets in your fund’s portfolio.
5. Rolling Returns: Rolling returns are average annual returns for a specified timeframe with returns taken into account till the last day of the duration. It reflects the relative and absolute performance of the fund at regular intervals. It is sometimes a better measure than CAGR (compounded annual growth rate) because a CAGR reflects the fund's performance at the time of calculation but not how it performed during the entire period. Rolling returns can be more effective, accurate, and unbiased as they show how the fund performed during the entire duration.

The above parameters can help you judge the mutual fund performance helping you select the right one. Also, you must analyse if the fund's performance aligns with your financial goals in the future. Once you have chosen the right fund, you must keep tracking its performance periodically to ensure it's suitability according to your goals and risk profile.

The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.