7 Ideas to Pick the Best Mutual Fund for your Portfolio

Mutual Funds are a boon to the common man who wants to invest in the equity markets but does not have the time or the knowledge to make a profit out of picking the right stocks. But, not all mutual funds are making profits. There have been funds that have performed miserably eroding the investments of the investor who trusted them. So, the onus is now on choosing the right fund which is going to give you a profit. Afterall, that is all we want right? Our money to earn more money for us…

Well, this article is about giving you 7 ideas that would help you choose the right mutual fund for your portfolio…

Lets get started!!!

Before we begin, let me tell you that these ideas are in descending order of importance. That is, idea 1 is of greater importance than idea 2 and so on.

So, a fund that meets, lets say the first 5 ideas but fails the last 2 is better than one that meets the first 4 and fails in the last 3.

Idea 1 - Does the Mutual Fund match your ‘financial profile & needs’?

Mutual funds offer a whole variety of products such as aggressive equity funds, index oriented funds, gilt funds, income funds, liquid funds, gold funds, Sector Specific funds, etc etc. To be honest, the list is very long. But the point here is, you don't have to buy all of them. You need to choose the fund that suits your financial profile.

For ex: A youngster who has just started earning and is planning on setting up a family soon or buy a house would need to choose an aggressive equity fund whereas the gentlemans father, who is retired and is planning on using his corpus for his life post retirement, he would have to choose debt oriented funds.

So the requirement of the individual and his financial profile is the single most important determining factor in choosing a fund.

The Idea here is – Choose a fund that will suit your financial profile and needs. Don't buy unwanted fund categories.

Idea 2 – Check the Funds Past performance

The past performance of the fund is one of the most important criteria in fund selection. That is why it is the no.2 on our ideas list.

Everyone knows that the past performance of a mutual fund may or may not be sustained in future but the fact is, a fund that has outperformed the index and its peers is always a good bet when compared to another fund that has underperformed.

Some funds outperform the markets in spurts and bursts but fail to sustain the momentum whereas some of them have consistently outperformed the markets for years…

The idea here is – Choose a fund that is a consistent performer who has provided solid returns on investment year after year.

Idea 3 – Check The Fund House and The Fund Manager

Investment is both a science and an art. Good research teams i.e. the science part of investing, are necessary in identifying the best possible opportunities available in the market. A good fund manager will not only buy the right stocks at the right time but also, sell them at the opportune moment to make the most profit for his investors.

Two fund managers could react in a different way if given the same amount of money and the same set of stocks to buy. A lot of impetus is on the fund managers choice of stocks and his timing of buy and sell. Also, a significant influence in the fund managers decisions is the fund house. Certain fund houses have a track record of solid performance and they strive very hard to keep up the same. Hence a combination of a good fund house and a smart fund manager is the best possible combination.

The idea here is – Select a Fund House that has a history of solid performance and a Fund Manager who has given solid returns on investment would be a strong investment choice…

Idea 4 - Is the AUM appropriate?

AUM – Stands for Assets Under Management – This is the amount of money at the disposal of the fund manager to invest in the markets.

This again is one very important consideration but not the most important. To be honest, the size of the Fund that is being managed by a fund manager doesn't have any bearing on the returns generated. A capable fund manager could manage a multi-thousand crore fund portfolio better than another mediocre fund manager who is managing only a few hundred crore portfolio.

There is no mathematical rule that can tell us the best size for a given mutual fund. But, the rule of the thumb is, a fund that is too large makes it difficult for the fund manager to sustain the momentum and continue to generate the kind of returns that were generated when the funds assets were more manageable.

Having said that, AUM could be an important factor in the fund’s overall performance! In all probability, a fund manager managing a smaller fund will be able to diversify his investments better than the manager who has an ultra-large portfolio to manage.

The idea here is – Choose a Fund that is large and has a good AUM base but at the same time, don't choose one that has ultra-large AUMs that have become practically unmanageable for the fund manager. At the same time, avoid funds with ultra small AUM.

Idea 5 - Risk parameters

The Risk Parameters of the fund have a strong bearing on the returns generated by a mutual fund. Practically speaking, two funds may deliver the same returns to its investors but, I would personally choose a fund that does it by:
• Taking lesser Risk
• Consistently – year after year
• With less volatility when compared to the market.

Therefore, after you have short-listed the funds based on the performance, portfolio, fund house etc., check the risk parameters and opt for those that tend to deliver good returns despite taking lesser risks.

The idea here is to – Choose a fund that gives good returns and at the same time takes lesser or rather educated risks instead of reckless risks that can backfire.

Idea 6 - Annual Recurring Expenses

The amount of returns generated by your portfolio are directly influenced by the amount of money expended by the fund house. The expenses done by the fund house will eat into your returns. These expenses include management fees, custodial fees, marketing and selling expenses, trustee fees, auditing fees etc.

Before you start to get too worried about these fees, remember that the SEBI and AMFI have set certain maximum limits on how much a fund house can spend on these expenses. That being said, some fund houses spend as much as SEBI and AMFI allow them, whereas some fund houses keep their expenses controlled and pass on this profit to their investors.

I guess, you already got the whole idea. A fund that has lesser expenses is always better than one that has high expenses.

The idea here is – Choose a fund that is able to manage its expenses and keep them as low as possible. Avoid funds that have a history of overshooting their expenses thereby eroding the returns for the investors.

Idea 7 - Entry & Exit Loads

Last but not the least, the entry and exit loads on the mutual funds is an important consideration on choosing a mutual fund.

Entry load: As per the recent regulation, SEBI has mandated that with effect from August 1, 2009 there will be no entry loads for all mutual fund schemes.

Exit Load: This is the load payable when you sell of your MF units. The exit load is generally payable only if you fail to satisfy certain pre-specified conditions. Therefore, in most cases you may not find a compulsory exit load but eventually you will pay an exit load if you fail to meet the specified condition. For ex: if you sell a equity diversified mutual fund before 1 year of purchase, you will end up paying a 2% exit load.

A lower load is always better. However, since the load is nominal, sometimes even paying higher loads may be fine if the fund’s performance and other factors are very good.

I would choose a fund that has a 2% exit load but has been consistently performing for the past 10 years over a fund that has only a 1% exit load but has been volatile in its performance.

The idea here is to – Choose a fund that has a low entry/exit load but at the same time choose one that does justice to the load they charge.

Happy choosing good mutual funds & Happy Investing too!!!