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Risk-return tradeoff gets thumbs down - Views on News from Equitymaster
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  • Aug 20, 2003

    Risk-return tradeoff gets thumbs down

    Surprisingly, a large section of the investing community (54%) consider themselves proficient enough to gauge a good mutual fund investment on the strength of its portfolio. That was the most significant finding of the latest poll conducted on our website.

    Over half the visitors Ė 54%, polled in the survey opined that they would select a mutual fund based on the fund portfolio. Nearly a third of the audience (32%) said they would select a fund based on the (reputation of the) asset management company/fund house. The fund manager was a good enough reason to invest for 14% of the viewers.

    The results of the poll are significant because investors seemed to find themselves up to the task of gauging a mutual fund portfolio in selecting the Ďrightí mutual fund. To research and comprehend the dynamics that drive a single stock/sector can be quite a demanding task. A mutual fund portfolio has several stocks (starting from 20) and sectors (starting from 15)! That is why even a fund manager finds himself incapable to do this all by himself and employs a team of analysts to assist him. And we havenít even started discussing debt funds where competent fund management skills are as, if not more critical. If we have 54% of our visitors who believe they can do this all by themselves, then we have a latent fund management potential in the country that must be tapped!

    We believe, that there are a variety of factors apart from the fund portfolio that investors need to consider before selecting a mutual fund.

    • Investors need to understand that a portfolio only indicates the investments of a mutual fund at a point in time. By itself it means very little. If investors do believe in looking at a fundís portfolio, they should probably look at the fundís trailing 5-10 monthsí portfolios. This will allow them to understand the fund managerís style of investment over a period of time, i.e. whether he is an investor or a punter.

    • Understanding the fund managerís style is important mainly because it dictates the risk profile of the mutual fund. A fund managerís investment philosophy (concentrated bets, diversified portfolio, large caps, mid caps) gives the fund a particular risk profile. Investors need to gauge the risk profile of the fund well.

    • Understanding the risk profile of the fund is critical to understand whether it fits your own risk profile. There is nothing wrong in a fund manager adopting a conservative or aggressive strategy per se, so long as this has been adequately conveyed to the investor. Often the problem lies in the way the fund has been projected or sold by the fund house. In 1999-2000, sectoral funds were sold as an easy way to make money by taking on moderate risk while there was nothing farther from the truth. There is nothing unethical in a sectoral fund, but it can become unethical if the risk-return trade-off is not sufficiently communicated to the investor. We believe this is the most significant factor that investors must consider before choosing a particular fund i.e. to match the fundís risk profile with your own.

    • A long-standing track record of performance and delivering value under various phases (bullish as well as bearish) over an extended time frame of 3-5 years is another very big plus.

    • The track record of the sponsors/AMC/fund house is also a very important factor. Investors draw comfort from knowing that the sponsors have adequate fund management experience and have a clean slate untainted by scams and financial irregularities.

    In our interview with Mr Vivek Reddy (ex-CEO of Pioneer ITI Mutual Fund, which was acquired by Franklin Templeton Investments), he had this to say about his selection criteria for a mutual fund, ĎOn a scale of 1 to 100, where 100 indicates a fail-safe investment decision, I would give track record, portfolio and performance a weightage of about 15%. I would give expenses a weightage of 10%. I would give service levels, responsiveness a weightage of 10%. The sponsors and promoters would get a weightage of 5%. That leaves you covered for 40%. I would say thatís about the best an investor can do and leave the rest to God!í



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