Analysing Mutual Fund Performance

Priya said, "Ravi, I've been wondering—how do we know if the funds we've invested in are performing well?" as they sat down to examine their expanding mutual fund portfolio. What ought to be our focus? "That's a great question, Priya," smiled Ravi. There is so much more to it than just returns. To help us make more assured decisions, let's examine the most important metrics for assessing a fund's performance.

When you look at mutual funds, you most likely want to know if they are performing well. The first thing to look at is the fund's cumulative earnings. Examine the returns over a range of periods, such as one, three, or even five years. Longer-term performance reveals how well a fund performs, even though short-term returns may appear fantastic. It's usually a good sign if it has performed well regularly. However, it might not be as impressive if the returns only increase for a single year.

Still, returns alone aren’t everything. You also need to think about risk. Some funds might give you great returns, but they could take many risks to get there. You should look at risk-adjusted returns to determine if a fund is risky. This tells you how much return you’re getting for the amount of risk the fund is taking. A common measure here is the Sharpe ratio. The higher the Sharpe ratio, the better the fund balances risk and reward. So, it’s not just about making money—it’s about making money without taking too much risk.

The next is the expense ratio: All funds have some expenses related to management and administration. The expense ratio shows the percentage of your investment for these fees. It might not seem much, but it adds up over time. A fund with a low expense ratio is better since it shows more of your money is working for you. But do remember that some funds have higher fees, and if they pay off with higher returns, it may be worth it.

Another important factor is the fund manager. The fund's performance is heavily dependent on the manager's performance. Experience and a good performance record are definite plus points. Consider the fund manager's performance history with other funds under their supervision. Past performance for their current fund may be encouraging.

You should also look at the fund's holdings, including the types of assets it invests in, including small-cap and large-cap stocks, and investments in particular industries like technology or healthcare. The performance of such a fund will be ensured by the asset mix represented in the fund. On this basis, its investment must lead to reaching your goals. Still, you can invest in large and reputable corporations for safer options. However, you may want to attract smaller, growth-oriented businesses to invest in this fund if you accept the risk in exchange for higher returns.

Remember to pay attention to the fund’s consistency. A good fund doesn’t just perform well in a single year; it’s about steady growth over time. Some funds have great years and then drop off the following year. Consistency when choosing a fund is key. Thus, look for a fund that has returned solid results over the long term if that's not the highest every single year.

Lastly, check the fund benchmark. A benchmark is a comparative point; it could be a representative index or a pool of similar funds. If the fund has been regularly outperforming its benchmark, that is an assurance that it is doing well compared to others in the same category. On the other hand, if it’s lagging behind its benchmark, it might not be the best choice.

Conclusion:

Priya went through the metrics and said, "Whoa, there's just so much to consider, apart from just returns." The good news is that the consistency and risk-adjusted return are given just about as much emphasis. "Exactly," Ravi said. "It does get rather easier once you start viewing the larger picture.

In the following chapter, we discuss how to make these more actionable through case studies and real-life instances that best show how different options and strategies play out in the real world.