Many investors in equity markets prefer to invest through mutual funds (MFs). There are many advantages in taking the MF route. If you pick a good fund then you are saved of the trouble of analyzing individual stocks as well as the stock market. MFs can provide adequate diversification and decent long term returns. Many people view MFs as a good way to lower their overall risk when investing in equities. However, there are a few key risks that one must be aware of while choosing a good Equity MF.
If you are a long term investor in Equity MFs, you should keep factors like portfolio churn as well as the fund manager attrition risk in mind. The churn in a mutual fund portfolio is a bigger risk than many people realize. The churn as measured by the portfolio turnover ratio is higher than 100% in many popular mutual funds in India. In simple words this means that the fund manager has turned over the entire portfolio once in the last 12 months. If you are uncomfortable with such a high churn, you should consider switching to another fund.
The fund manager risk is another important aspect in mutual fund selection. If you have two funds in your portfolio managed by the same individual, you are compromising on diversification and increasing your risk. Then there are certain fund houses that witness a lot of attrition when it comes to the fund managers. If the new fund manager is not up to the job, it will affect the returns of the fund negatively. In case there is such a change in one of your MF holdings, it would be prudent to have a look at the new fund manager's track record before taking a call on your investment.
Also of concern to long term investors should be the theme of the fund. For example, if a fund manager of a dedicated large cap fund were to start investing aggressively in mid and small cap stocks, it might be a good idea to exit the fund.
We believe that long term investors should pick Equity MFs not just on their long term performance. But the above mentioned risks should also be given due consideration. In addition, investing through the Systematic Investment Plan (SIP) route will also help to lower the risk of market fluctuations. Finally do remember to consult your financial advisor before making long term investments in equity markets.