Mutual funds pool the money invested by investors and provide professional fund management to create and maintain a healthy portfolio, helping the investors to generate returns based on the returns given by the underlying securities in the portfolio. For the investors who do not understand the market nuances and who have just started investing into markets, mutual funds tend to be the ideal investment product, due to investment decisions backed by intensive research and analysis by a team of experts.
However, investors must realise that investing is indeed a journey and not a destination in itself. As such, it makes sense to check once in a while that you are on track to reach your destination in time. As such, the investors must review their mutual fund portfolio on periodical basis, to continue with good schemes, instead of letting bad schemes pull down the overall portfolio returns. Such a review also allows the investor to align the investment portfolio with the changes in risk profile and financial goals. However, one question that might be making rounds in your mind is, how to track the mutual fund performance?
Some of the retail investors tend to make a straight forward comparison of mutual fund schemes through their NAVs. For example, a mutual fund scheme with NAV of Rs. 20 might be considered as performing better than one scheme with NAV of Rs. 15. However, this is certainly not the right approach to compare two mutual fund schemes. This is not a comparison at all, as the growth in NAV depends upon the market cycles and the time since inception of the mutual fund scheme.
However, the investors can compare the periodic returns from the mutual fund scheme and mutual fund fact sheets can be helpful in this respect. Fact sheets disclose crucial and vital information about the scheme, which can help you analyse the performance of the scheme. In terms of SEBI Regulations, mutual funds are required to disclose 1-year, 3-year, 5-year and since inception returns of the scheme and the total returns (capital appreciation and dividend) generated by the benchmark index during the same period, referred to as Total Return Index (TRI). As such, it gets easier for investors to compare the performance of different mutual fund schemes during the similar investment periods.
With the comparative returns of the benchmark index also required to be disclosed, it is convenient for the investors to check if the mutual fund scheme is performing better or worse than the benchmark index, commonly referred to as outperformance or underperformance respectively. The difference between the fund returns and the returns generated by the benchmark index is referred to as alpha. If the fund is outperforming the benchmark index, it will have a positive alpha, and if the fund is underperforming the benchmark index, it will have a negative alpha. As such, it is always a prudent strategy to replace the funds with negative alpha with better performing funds.
An outperformance against the benchmark index reflects upon the ability of the fund manager to deliver better returns across different economic cycles, as the mutual fund scheme has been able to generate higher returns with similar macroeconomic conditions, on account of better stock-picking. Further, the investors must make a comparison of the mutual fund schemes over longer-term investment periods. So, instead of comparing the 1-year performance, a comparison of 3-5 year performance may make more sense for the investors. A positive alpha over a more extended period reflects the consistency of the returns for the investors.
It is a reasonable expectation for the investors to expect the returns to be proportional to the risk taken. So, the higher the risk taken, the higher should be the returns. No wonder, investors expect higher returns from their equity portfolio, as equities are considered to carry a higher risk weight than a plain vanilla debt portfolio. The investors seek fair compensation through higher returns for higher risk undertaken in the equities. As such, the mutual fund performance must also be gauged against risk-adjusted returns. A statistical ratio, referred to as Sharpe Ratio, can help you compare the returns of the mutual fund scheme for every additional unit of risk undertaken. A lower Sharpe Ratio indicates that the fund is not generating returns commensurate with the scheme risk. The fund fact sheets also disclose Sharpe Ratio with the other relevant details of the mutual fund schemes.
As such, you are not required to be a chart specialist to track the mutual fund performance and can refer the mutual fund factsheet for all the relevant details to perform such a review. Make the most of such portfolio review to maintain a healthy investment portfolio.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.