How to select the best performing Mutual Funds?

Investors want to end up with the best mutual funds which gives high returns. The entire selection process has to be guided by three basic pointers i.e. your life goals, risk profile and investment horizon.

Investment Objective

Any investment should be made after considering one’s personal life goals. Once you have assessed your needs, match it with your fund’s objectives. Each mutual fund has an investment objective which may or may not match your goal. To arrive at a meaningful decision, select funds which conform to your overall financial plan and risk appetite. A long-term objective cannot be funded with a short-term scheme. Similarly, a risk-averse investor should not invest in a highly risky fund. You can get all the details about the scheme, including its objective, strategy and asset allocation in the key information document and scheme information document.

Fund History

You may begin the shortlisting process by looking at the fund history. A mutual fund should have a long track record for being considered for investment. It shows the strength of the fund during tough times. A recently launched fund may or may not perform well during bear runs; it is yet to be explored. On the contrary, a fund with a good track record of consistent performance indicates the accuracy of its investment strategies.

A fund which has a history of say at least 5 years may seem eligible for shortlisting. At this point, you need to consider keeping your investment horizon in perspective. If you have a longer horizon, you may look at 7 or 10 year returns.

Financial Ratios

Risk and return go hand in hand. Returns are the increase in the value of the initial investment as a result of investing in a security like a stock or bond. Risk is the uncertainty concerning the actual returns not falling in line with the expectations. Before finalizing a mutual fund, you need to examine its risk-return potential.

This can be easily done with the help of financial ratios. Sharpe Ratio and Alpha come handy to indicate the relevant information. Sharpe Ratio shows the extra return that the fund has generated for every additional unit of risk taken. A fund having a higher Sharpe Ratio is better than the fund having a lower Sharpe Ratio. Similarly, Alpha tells you how much extra return has the fund manager generated as compared to the benchmark. The higher the alpha, the superior would be the fund.

Expense Ratio

Expense ratio is an essential parameter that needs to be analysed while selecting a mutual fund scheme. It is an annual fee, expressed in percentage, that the fund house charges for managing your money. The extent of expense ratio charged affects the fund’s returns. Thus, a higher expense ratio translates into lower returns for the investor. So, you may choose a fund which has a lower expense ratio as compared to peer funds in the category.

Performance of Fund manager

Fund manager plays a crucial role in the performance of a fund. Even though the entire investment is process oriented, still fund manager is the one who has to take care of the ultimate responsibility and keep the show going on smoothly. It is important to know the track record of the fund manager. You may check performance of the fund during market rally and slump. A fund which has given consistent returns and contained losses during the bear runs shows robust fund management. The fund’s alpha reflects how much extra returns did the portfolio generate due to fund manager’s efforts.