Should You Invest In A Mutual Fund Scheme Looking At Its AUM?

Feb 28, 2019

Mohan, a mutual fund distributor, is slightly conservative and lazy. He abhors the pain of researching schemes to shortlist the best ones for his clients. Nonetheless, he tries to protect his hide when recommending schemes to his clients. But often ignores the client's financial circumstances, goals, and objectives. Instead, he suggests popular schemes in each category, so that his clients aren't exposed to the risk of investing in any odd scheme.

Mohan's criterion to qualify a mutual fund scheme as a popular scheme is simple. He believes, bigger the scheme, higher the responsibility and better the performance. Hence, he advises clients to always invest in schemes with large Assets Under Management (AUM).

[Read: Equity Mutual Funds With Large AUM-Is Big Better?]

Ankit, a novice investor, took such advice seriously.

And unfortunately, he invested in three funds featuring in the tally of top-10 funds ranked on Assets under Management (AUM).

These three schemes in his portfolio have performed as bad (or as good) as any other average scheme over the last one year. Their performance has been ordinary even over a 3-year and 5-year period.

How seriously would you take your mutual fund distributor if they advised you that bigger funds are always better?

Big Schemes: True to fame or a sham?

You would be surprised to know, none of the top-10 schemes (AUM-wise) has outperformed the Nifty Total Return Index (TRI) in CY 2018. Moreover, just four schemes managed to outperform the Nifty-TRI over the 3-year period. Fortunately, nine schemes outperformed Nifty-TRI over the 5-year period.

Massive fall in the mid and small cap stocks over last one year has eroded years of gains of many mutual fund schemes, thereby affecting the 3-year performance of even the popular schemes. On the other hand, the phenomenon of only a handful stocks driving the index returns has made the exercise of stock picking difficult for fund managers.

Under such circumstances, investors seem to have started favouring passively managed index funds. But for a long term, investing in actively managed funds is still a better strategy.

Some diversified mutual fund schemes such as Mirae Asset India Equity Fund, Axis Focused 25 Fund and Reliance Large Cap Fund have outperformed broader markets across timeframes. While this doesn't necessarily make them schemes to buy, it indicates that bigger schemes aren't always better. There are many smaller funds out there that have the potential to beat the markets.

Prefer smaller funds over popular funds...

Smaller or less known funds aren't underperformers. They aren't even conviction bets.

However, compared to others, they have not reached the tipping point yet. Meaning, they haven't been very popular amongst investors and are still small in size. Nevertheless, many of these have the potential to be the star performers of tomorrow.

However, identifying future outperformers and investing in them early is the key. Investing in such hidden gems that are yet to be discovered by the market participants can prove to be lucrative.

One of the traits of these undiscovered funds are that they have the potential to prove their mettle by performing well across timeframes and market cycles and even manage their risk well. This is because they are relatively small in size, which makes them capable of being actively managed by fund managers. Moreover, they hold a highly liquid portfolio, where the fund manager can immediately change the strategy or quickly liquidate holdings if any of his bets does not meet expectations.

Along with quantitative parameters, many less known funds depict strength as regards to the qualitative aspects as well. And as mentioned before, they are small sized- typically having Assets Under Management (AUM) of less than Rs 2,000 crore, as of now.

You should always look for five elements to discover the hidden gems:

1. The fund manager possesses decent experience and is not overloaded with multiple schemes. Moreover, the fund house should have well defined investment systems and processes in place.
2. The fund has successfully generated positive returns across market cycles, viz. bulls and bears. It is important for the fund to limit your losses during market downswings.
3. The track record of the fund in terms of generating return on investment over various time periods like 1-year, 3-years, 5-years, and so on.
4. The fund must offer adequate return for the risk incurred. It should not be exposing you to unnecessary risk.
5. The portfolio should not be too concentrated, highly churned, or low quality. It should be managed efficiently.

If you have the time and skills, the job of identifying future leaders isn't that difficult.

At PersonalFN we follow a SMART Score Matrix, where the mutual fund schemes are selected on the basis of five variables: Systems and Process, Market cycle performance, Asset management style, Risk-reward ratios and Performance Track Record.

[Read: Why Selection Is Crucial To Make Solid Gains With Mutual Funds ]

But before you discover the hidden gems or undiscovered funds as we call them, make sure that you have/are;

• Identified your financial goals
• Calculated the amount you may require to achieve the financial goals
• Aware of the time horizon before the envisioned financial goals befall
• Aware of your investment objectives
• Assessed your risk profile
• Chalked out a personalised asset allocation plan based on the above
• Your investments aligned with your financial goals.

Finally, when you invest in equity mutual funds, prefer Systematic Investment Plans (SIPs) and choose the Direct Plan. Because the lower expense ratio of a Direct Plan compared to a Regular Plan can contribute significantly in the process of wealth creation in the long run.

Editor's note:

Believe us, unusual and lesser-known funds are capable of generating big gains for you. Some hidden gems are managed well and have the potential to deliver superior risk-adjusted returns in line with the popular peers in the category.

But any small sized fund will not do. You do not want to pick lesser-known funds that have delivered a one-off performance. You need the 'right' ones that can appealingly generate wealth for you.

PersonalFN's special report '5 Undiscovered Equity Funds With High Growth Potential' will help you invest in some of the hidden gems. PersonalFN has tested the viability of Undiscovered Funds featuring in this report by applying a stringent selection process.

What are you waiting for? Subscribe to the special report - 5 Undiscovered Equity Funds right now!

Author: PersonalFN Content & Research Team

This article first appeared on PersonalFN here

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