Mutual Funds - Effective selection for investment success

By - Hemant Rustagi
CEO, Wiseinvest Advisors

One of the hallmarks of the growth of the mutual fund industry in India has been its ability to offer a variety of funds to suit the needs of investors with varied risk profiles and investment goals. However, to get the best out of MFs, investors must focus on making the right selection keeping in mind their risk profile, investment goals, time horizon and the suitability of the product.

Unfortunately, many investors follow a haphazard approach for investing in mutual funds, which either results in disappointment or drags them beyond their risk-taking capacity. As a result, their portfolios often under-perform the benchmark as well as the peer group. Remember, that it is portfolio composition of the scheme i.e. the quality of the portfolio as well as its exposure to different market segments, viz. Large-Cap, Mid-Cap and Small-Cap, that influences the levels of rise and fall in the NAV. Also, it is equally important to understand the likely impact on the portfolio’s performance in case the markets turn bearish or volatile.

As is evident, the selection of a fund has a role to play in the kind of returns it might deliver and the riskiness or volatility that one may have to encounter while achieving those returns. Different types of funds react differently in a rising as well as a falling market, because different segments of markets react in various ways. For example, a Mid-Cap fund generally suffers more than a Large-Cap fund in a falling market. Thus, investors who do not follow a proper strategy may suffer greater losses than those who develop a well-balanced portfolio.
The exposure to different market caps should be in line with one’s risk profile. Needless to say, there cannot be a standard combination applicable to all kinds of investors. While deciding on the allocation, one has to keep in mind the composition of the entire portfolio. For a new investor, the right way to begin is by considering funds that invest predominantly in Large-Cap stocks. The exposure to Mid- and Small-Caps can be enhanced over a period of time.

It is always advisable to take professional help to decide the allocation as well as to select the appropriate funds. However, taking help from professionals doesn’t undermine the role that investors themselves need to play in this process.

All Award-Winning Funds May Not Suit All Investors

Many investors feel that a simple way to invest in mutual funds is to just keep investing in award-winning funds. First of all, it is important to understand that rather than the awards, the methodology of choosing winners is more relevant. A rating firm generally elaborates on the criteria for deciding the winners, i.e. consistent performance, risk-adjusted returns, total returns and protection of capital. Each of these factors is very important and has its significance for different fund categories.

Besides, each of these factors has a varying degree of significance for different kinds of investors. For example, consistent returns really focusses on risk. If an investor is afraid of negative returns, consistency will be a more important measure than the total returns, i.e. NAV growth and dividend received. A fund may have impressive total returns over time, but can be extremely volatile and tough in the interim for a risk-averse investor.

Therefore, not all award-winning funds in the various categories are suitable for all investors. Typically, the first step when selecting funds should be to consider personal goals and objectives. Investors need to decide which element they value the most, and prioritise the other criteria after that. Once investors know what they are looking for, they should go about selecting the funds according to the asset allocation. Most investors need just a few funds that are carefully picked, watched and managed over a period of time.