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Why Qualitative Aspects Are So Important To Pick Mutual Funds - Outside View by PersonalFN

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Why Qualitative Aspects Are So Important To Pick Mutual Funds
Nov 26, 2018

If you check the past performance of a scheme, but not the track record of the fund house offering the scheme before investing in it, your investment strategy could fail.

You might ask: 'Why should the track record of the mutual fund house matter to me when I am interested in just one scheme?'

The answer is rather simple; that's because a scheme's performance mainly depends on how the fund house is doing overall in managing investors' hard-earned money.

Although some fund houses may have one-off winners in their product offerings, great mutual fund schemes often come from fund houses that follow robust investment processes and systems.

Assessing the mutual fund schemes on qualitative parameters is extremely necessary when selecting a winning mutual fund scheme for your portfolio.

In simple words, parameters that you can't assess just by number crunching are the qualitative parameters.

In this article, we will discuss what the qualitative parameters are and why are they essential.

Qualitative parameters:

Fund manager's experience

When it comes to dealing with health issues, wouldn't you prefer to go to experienced doctors and specialists? There's no reason to treat your mutual fund investments differently. You may not want any inexperienced fund manager to manage your hard-earned money. Hence, invest in a mutual fund scheme managed by an experienced fund manager.

But here's a word of caution.

While you check the experience profile of the fund manager, do bother to check the past record of the fund manager and consider the present performance of all other schemes managed by him/her as well.

Mere experience isn't enough.

Some schemes managed by fund managers with 15-20 years of experience have never done consistently well for a long time. How does it help to have your mutual fund scheme managed by such a person?

Similarly, basing your investment decisions on the past track record of the fund manager isn't a good idea. Historically, they might have done well for investors, but if all schemes managed by him/her aren't performing well for a considerably long time, it's better to rely more on the present performance and avoid such schemes.

If you look around carefully, you will come across many such cases.

But it's unfair to blame a fund manager, as there can be other genuine reasons for the scheme's worsening performance. This leads us to the second most crucial qualitative aspect.

Performance pressure on the fund manager

Sometimes, fund managers' success becomes their biggest enemy. As they perform well consistently, fund houses and investors, start building a greater trust in them. At some point, the quantum of activities becomes unmanageable for the fund manager.

If money keeps flowing into just a few schemes and their Asset Under Management (AUM) swells, it directly affects the flexibility of these schemes. The fund manager is then compelled to invest even when there aren't adequate investment opportunities just because sitting on cash isn't a desirable option.

On the other hand, as well, if a fund manager performs consistently, the Asset Management Company (AMC) gives additional responsibilities by launching New Fund Offers (NFOs) or appointing him/her to manage some poorly performing schemes as well, hoping to turn them around.

[Read: Are Fund Houses Opening Up Their NFO Factories Again?]

Therefore, be always wary of a fund house wherein the Schemes-to-Fund Manager Ratio is high. To put it differently, if a fund manager is managing multiple schemes with a large AUM single-handedly, their performance is likely to suffer. Thus, avoid betting on schemes offered by such fund houses.

Reliance on a handful of star fund managers

If a fund house is relying excessively on a few of their star fund managers, it's likely to disappoint you someday when fund managers resign at their discretion. With no backup plan, taking over a good performing scheme is a difficult task.

Therefore, always invest in schemes offered by fund houses that build strong investment processes and make fund managers follow them, irrespective of their stature in the industry. This works exceptionally well for investors as the process-driven investment decisions are often unbiased and hence effective.

Have an eye on the NFO launches and their frequency

If a fund house decides to cash-in on the good reputation of their fund managers and opportunities presented by the markets, it will launch NFOs greedily. This has happened in the past.

Fund houses flooded the markets with their NFOs at a time when markets were scaling to new highs and valuations were unsustainable. They looked greedy in the race to garner more AUM-- similar to promoters of companies that disenchanted investors by launching Initial Public Offers (IPOs) during late 2007 and in early 2008 and failed to generate wealth.

Portfolio characteristics

Portfolio churning and portfolio concentration also give you a hint about the fund house's investment philosophy. If a fund manager frequently churns the portfolio of a scheme, he could be following the market momentum. Similarly, although a concentrated portfolio echoes conviction, it exposes you to higher risk. You would be better off avoiding schemes with highly concentrated portfolios and that is frequently churned.

[Read: A Portfolio Strategy That Could Help You Reduce Shocks Of The Equity Market]

Do note that while the historical performance of mutual fund schemes is just the start point, understanding the qualitative aspects would help you recognise how a mutual fund scheme is likely to perform in future. Hence, never ignore the qualitative aspects to select winning mutual funds.

Watch this video on how to select mutual fund schemes for your portfolio:


Need more information?

You may read PersonalFN's mutual fund selection methodology.

At PersonalFN, we believe it's not only important to carefully select the mutual funds but to know which funds would suit you the most.

Before you invest in mutual funds, you should know:

  • Your age;
  • Your current financial health;
  • Your risk profile;
  • Your investment objectives;
  • Your financial goals; and
  • Time horizon before financial goals befall

Based on the above, chart out your asset allocation and then invest in mutual funds. And to get the best results, invest in the direct plans of carefully picked mutual funds through Systematic Investment Plans (SIPs).

Editor's note:

Selecting the right mutual fund scheme for your portfolio is a skilful and time-consuming job. If you lack either or both of them, it's best to seek professional advice.

PersonalFN's unbiased premium research service-FundSelect is meant for you.

Every month, PersonalFN's FundSelect service will provide you with insightful and practical guidance on equity mutual funds and debt schemes - the ones to buy, hold, or sell. Our aim is to assist you in creating the ultimate portfolio that has the potential to top the market.

With FundSelect, you get access to high quality and reliable funds picked by our research team using their comprehensive S.M.A.R.T. score fund selection matrix.

S - Systems and Processes

M - Market Cycle Performance

A - Asset Management Style

R - Risk-Reward Ratios

T - Performance Track Record

If you are serious about investing in a rewarding fund, subscribe to PersonalFN's flagship mutual fund research service FundSelect today!

Author: PersonalFN Content & Research Team

This article first appeared on PersonalFN here.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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