The exuberant phase of the equity markets, are often sunny times for several manufacturers of financial products and investors. While some smart investors prefer to book profits during such times, there are several who elevate their confidence during euphoric times. And interestingly banking on the upbeat investor mood, manufacturers of financial products too, launch new financial products. Have you wondered why such financial products aren't launched when sentiments in the markets are low? Well, the answer in our view is simple. They (manufacturers of financial products) want to make hay when the sun shines, by garnering more Assets Under Management (AUM) during euphoric times, when investor sentiments are upbeat.
Take for instance the recent past; there have been number of New Fund Offerings (NFOs)from variousmutual fund houses as the Indian equity markets have scaled up by nearly 13.3% in the last 2 ½ months.While many get wooed by the Rs 10 investment proposition, in our opinion it may not always be prudent investment decision. In fact with 870 equity mutual fund schemes already in existence (including the options therein), addition of new schemes, in our view creates a dilemma in the minds of the investors, as to how they should rightly select and invest in winning mutual funds. While there is galore information to address to this issue, we think that "information overload" could actually confuse investors and make the task of selecting winning mutual funds tougher rather than easier.
While many may argue that you can simply go with star rated funds, the question which arises to our mind iscan these star rated funds be like real rock stars in your mutual fund portfolio.Today, interestingly the media - both print as well as the electronic media, also sermon about star rated funds so often, that it has an influencing impact on the minds of many investors. Banking on this environment, mutual fund distributors / agents / relationship managers too are busy persuading their clients to invest in star rated mutual funds. But question still remains unsolved, "are you buying rock stars or winning mutual fund schemes to your portfolio?"
It is vital to recognise that just having blind faith and following the norm that more "stars" there are on the scorecard, better is the fund's performance; sounded good or logical during our school days when a 5 star for our homework, connoted that we were good students.
But it is vital to recognise that evaluating a mutual fund's performance is far different!
It is noteworthy that most star ratings take into account only quantitative methodology considering the past performance (returns), expense ratio, risk (Standard Deviation) and risk-adjusted returns (Sharpe Ratio) of the respective fund. But they ignore the qualitative factors such as the fund house history, its credentials, the investment systems and processes followed by the fund house, portfolio characteristics, adherence to the stated investment objectives etc; which drives the performance of the fund in future.
Remember, forecasting the fund's future performance is no cakewalk. It is not a simple function of "sorting" on excel – as used in most of the rating methodology.
Moreover ratings subscribe to the "one size fits all" approach. They seem to suggest that if a fund has earned a top-notch position, investors across categories can invest in the same. But remember investing and financial planning are personalised activities. Hence, a fund could be right for one investor and (despite its sterling performance) be completely unsuitable for another. Yes, they could perhaps serve as starting points for identifying a broader set of investment-worthy funds; but investing in a fund, based solely on number of stars against its name may not be the right move.
The fact is, not all mutual funds are same. There are various aspects within a mutual fund scheme, which are vital for investorsto study carefully before investing; which are:
It just indicates the fund's ability to clock returns across market conditions. And, if the fund has a well-established track record, the likelihood of it performing well in the future is higher than a fund which has not performed well.
Under the performance criteria, we must make a note of the following:
PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.
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