How to Analyse Mutual Fund Performance: 7 Key Parameters

Mutual funds

The Indian mutual fund industry has increased its assets under management from Rs. 17.37 trillion in January 2017 to Rs. 38.01 trillion as of January 31, 2022. With this constant expansion in the investment world, there are several mutual fund schemes to choose from. 

Every day new investors enter this industry to diversify their investments and spread out the risks. For these newcomers and seasoned investors, mutual fund analysis has become vital in choosing funds that fit their portfolios the best. Here are the 7 key parameters to analyse mutual fund performance. Read on!

7 Key Parameters To Analyse Mutual Fund Performance

1. Compare Fund Performance with Benchmark Performance

While analysing a mutual fund’s performance, the first thing that most investors do is compare their fund with the benchmark. No matter which type of mutual fund you are aiming to invest in, each scheme has a benchmark index. 

A fund that constantly beats this benchmark index in the long term can be an ideal investment. It is crucial to find a fair and appropriate benchmark that is not biased. For debt-oriented funds, S&P BSE or CRISIL indices can be suitable benchmarks. 

Thus, if your chosen mutual fund scheme offers a 5% 1-year return and the BSE benchmark for this fund is 10%, then it is probably not a right fit. 

2. Compare the Expense Ratio of Funds

A fund house charges an annual maintenance fee–the expense ratio– to maintain and manage a fund. It includes management fees, distribution charges, security transaction fees, and investors’ transaction fees. 

According to SEBI guidelines, a fund house cannot charge an expense ratio of more than 2.25% of the fund’s AUM. Your returns are slightly reduced due to this fee. The higher the expense ratio, the lower your overall returns. Thus, it is vital to compare this fee across various schemes to ensure you do not lose a hefty proportion of your returns. The expense ratio varies significantly between a direct plan and a regular plan. 

These two plans are inherently the same, but you invest in a direct plan through the fund house and in a regular plan through a broker. In the latter, brokers charge a commission from the fund house, and this commission is added to your expense ratio. Thus, regular plans have a higher expense ratio.

Also Read: Top 10 Value Mutual Funds

3. Compare Fund History 

To conduct a mutual fund performance analysis, you need to scrutinise the long term history of the fund. In simpler terms, you need to analyse how a fund performs over a period of 5-10 years. Furthermore, comparing the returns it offers in bear and bull cycles also helps you validate its performance. 

Let’s say a fund delivers higher returns than the benchmark during a stable market but records significant losses during downturns. In this case, the fund has not performed well. 

4. Compare the Strength of the Portfolio 

By using financial ratios like Alpha and Beta, you can find out whether your fund can generate good returns with low risk. The alpha ratio measures the extra returns generated above the benchmark by a fund. In contrast, the beta ratio indicates its volatility. 

• Beta > 1 = Fund records gains or losses more than the benchmark
• Beta < 1 = Fund records gains or losses less than the benchmark 
• Beta = 1 = Fund records gains or losses same as the benchmark 
• Let’s say that you are comparing two equity-oriented funds, A and B. 
• Fund A: Alpha = 1.5, Beta = 2
• Fund B: Alpha = 2, Beta = 2

Given that the risk level is the same, it is better to go with fund B because it offers higher returns. 

Also Read: 5 Ways To Diversify Your Investment Portfolio in 2022

5. Compare Portfolio Turnover Ratio 

Here’s another way to run a mutual fund analysis. The Portfolio turnover ratio (PTR) is the percentage change in the number of assets in a fund in one year. It indicates how often a fund manager buys or sells assets in the portfolio. Well, how is this relevant?

If your manager is frequently trading securities, especially in equity funds, it can increase your transaction charges. Owing to a hike in brokerage or other fees, the expense ratio of a fund increases. Thus, it negatively impacts your take-home returns. 

In conclusion, while deciding on which fund to choose, try to compare the portfolio turnover ratio and select the one with a lower ratio. 

6. Compare The Maturity Period Of Funds

The maturity period is highly relevant in the case of debt funds. As these funds are sensitive to fluctuations in market interest rates, longer maturity periods can cause a decline in Net asset value (NAV). However, in periods of falling interest rates, the longer you stay in a fund, the more profit you earn. 

Thus, analysing the average maturity period of your portfolio, i.e., the mean of the maturity periods of all the funds, is crucial. It can impact your overall returns and risk profile.

7. Understand The Risk-Adjusted Returns

Annualised returns are an important parameter to keep in mind while going for a mutual fund analysis. But many investors also consider risk-adjusted returns. Guaranteeing lower risks is not always possible with mutual funds. Thus, a suitable fund is one that can adjust the higher degree of risk with higher returns. 

By measuring the risk using standard deviation, you can see how a scheme performs during market volatility. A higher standard deviation indicates higher risk volatility. 

On the other hand, by using the Sharpe ratio, you analyse the additional returns generated on each additional unit of risk taken. A higher Sharpe ratio indicates that your fund is offering above-average returns on the additional risk it takes. 

Final Word

Investing in mutual funds should not be a hasty decision. Selecting the right mutual fund schemes can help you build a strong portfolio and maximise returns. Thus, it is crucial to know the different parameters for mutual fund analysis to help you evaluate and pick a suitable fund. 

With Navi, you can follow the above-mentioned parameters and personally select the best-performing funds to fulfil all your financial goals. Visit Navi Mutual Fund and explore the different mutual fund schemes offered by this fund house. 

FAQs on How to Analyse Mutual Funds

1. Do all mutual funds have a lock-in period?

Most mutual funds are open-ended schemes that do not have a lock-in period. They offer high liquidity as you can redeem your investment on any business day. However, there are a few exceptions, like hedge funds and ELSS mutual funds. 

2. What is Macaulay’s duration?

Macaulay duration tells an investor the time in which they will be able to recover the price of a bond in the forms of interest payments and principal repayment. It calculates the weighted average time before investors can receive internal cash flow. 

3. Which benchmarks can I use during mutual fund analysis?

The benchmarks that Indian investors and fund houses use to compare a fund’s performance vary across the type of mutual funds. Some of the commonly used benchmarks are Nifty 50, S&P BSE, and CRISIL indices. 

4. What does CAGR mean in mutual funds?

The compound annual growth rate is the average annual rate at which your investment grows for more than one year. It helps you analyse the performance of your fund by letting you know the compounded annual returns you will earn. 

5. Which financial ratios help me analyse the strength of my mutual fund portfolio?

There are a few financial ratios that you can consider while evaluating the strength of your portfolio. These are Alpha, Beta, Standard deviation, Sharpe, and R-squared. All these ratios provide different information about the risk and returns associated with a fund. 

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Disclaimer: Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.

This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.