Mutual funds are increasingly finding greater acceptance among investors, when it comes to planning their finances. However, given the numerous schemes in each category, and many more being launched every month, how does an investor determine where to invest?
To start with, we recommend that you take a close look at the fund management team, in other words, the brains behind the mutual fund.
The fund manager, also known, as the 'Portfolio Manager' is an individual (although increasingly, he is being replaced by a team of two to three fund managers) who decides where, and in what allocation, money is to be invested.
Given the importance of the fund manager/fund management team, it is pertinent that you, the investor, evaluate him very carefully.
Here are some parameters on which you should evaluate the fund manager:
1. Adherence to mandate
Every mutual fund scheme has an investment objective, which the fund manager must adhere to. If the fund manager is not faithful to the mandate, then you may find yourself invested in a scheme whose objectives no longer match yours. And then of course, if you were to take corrective measures, there will be implications in terms of taxation and loads.
There have been instances when funds change their mandates depending on what's 'hot' in the stock market. Such funds again must be avoided as their focus is on asset accumulation and not money management. A fund manager who adheres to the mandate under all conditions regardless of market conditions should be preferred over one who does not.
2. Investment style
It is important for an investor to understand the investment style followed by the fund house. One way to classify investment styles is individualistic style and team-driven style.
The basic difference between the two is that in the former, you have a 'star' fund manager who plays an important (at times, even indispensable) role in taking investment decisions. In the other style, there is a team that takes the investment decision based on certain processes and systems.
The team has a fund manager who participates in the investment process, but he is not a star; instead, he takes the final call based on the team's consensus. Needless to say the second approach is a lot better; one key reason being there is no over-dependence on one individual.
Investors must be cautious while investing in a fund that pursues the individualistic brand of fund management. This is particularly so, since switching between fund houses is a common practice within the fund manager community.
Testimony to this fact is that apart from a few names, we can't think of many fund managers who have been associated with a fund house for more than even 5 years. When a star fund manager quits the fund house, the existing funds could witness a dip in performance. Also investors are hassled into tracking his whereabouts and then investing/redeeming their monies based on his latest employment.
One thing that is critical while deciding on which mutual fund to opt for is to ascertain whether the fund house has a process-driven approach to identifying the right investment opportunity. A process-driven approach brings in discipline, which in the long-term is a key factor in determining performance.
3. Evaluating performance
Higher returns or a rapidly appreciating NAV (net asset value) do not necessarily mean that the fund manager is doing the right thing. There is a lot more to performance than just the headline NAV return number. Among the 'numbers' one should focus on.
One, the most basic -- a comparison of the fund's performance over various time periods vis-à-vis both the benchmark index and its peers. The comparative performance, both absolute and risk-adjusted, will give you an insight into the fund manager's ability to outperform the peers and the benchmark over different periods of time. A well-managed fund should be a consistent outperformer.
Two, the performance of the fund during downturns in the market should be evaluated carefully. A fund managed by a smart fund management team should ideally fall a lot lower than the market due to the prudent investment calls. Remember, it's only in lackluster/bear markets, that the stock picking ability of the fund management team really comes into play (in bull markets almost anyone can deliver a return).
Above we have listed just three points for you to keep in mind when selecting the right fund manager/team while investing your money.
Once you select the right fund management team, you have made a start, but there is a lot more homework still to be done in terms of selecting the right mutual fund. An easier alternative is to engage the services of an honest and competent financial planner.
Buy Personalfn.com, a financial planning initiative. It can be reached at info@personalfn.com. Personalfn.com also publishes a free-to-download financial planning guide, Money Simplified. To get a copy of the latest issue - How ULIPs fit in - please click here.
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