Ask investors in the mutual funds segment, how they go about making investments and the responses are likely to be as diverse as they can be. While some investors replicate investments made by their friends and relatives, others simply invest in the top performing funds. Then there are others who stick to new fund offers and those who believe in investing in the season’s flavour. A common thread running through all the aforementioned is that their investment process begins with selecting a fund, rather than first selecting a fund house.
We believe that investors must first decide on the fund house. And once a fund house makes the grade, its offerings must be evaluated. This is important because the fund house’s investment philosophy plays a vital role in determining the performance of its funds. Hence, it is important for investors to evaluate the fund house on parameters like its fund management philosophy, investment approach and processes before making an investment decision.
While there are many parameters on which a fund house can be evaluated, we outline 3 important ones that investors must consider while selecting a fund house.
1. Process-driven as opposed to individual-led
Broadly speaking, fund houses can either be individual-led or process-driven. Investors would do well to understand both the aforementioned before selecting a fund house. The basic difference between the two is that in the former, there is a ‘star’ fund manager who plays an important role in taking investment decisions; whereas in the latter, the investment processes govern the investment decisions.
The star fund manager is typically an expert with a proven track record; hence, the star status enjoyed by him. The fund house essentially relies on the star fund manager to deliver results, something he is capable of doing. The trouble is that when the star fund manager quits the fund house (which incidentally is a common phenomenon in the mutual fund industry), he takes the performance with him. Hence, the funds could witness a dip in performance after his exit. As a result, investors may be forced to redeem their investments and track the star fund manager’s whereabouts, so that they can make investments based on his latest employment, to benefit from his investment expertise.
Conversely in a process-driven fund house, notwithstanding the presence of qualified and competent fund managers, investment processes tend to be institutionalised i.e. made independent of individuals. Therefore the exit of any fund manager is unlikely to have a significant bearing on the performance of funds. Simply put, a process-driven fund house is better equipped to deliver an enduring performance as opposed to a fund house that relies on a star fund manager. Hence, our preference is for the former.
2. Track record of funds
Another parameter on which a fund house should be evaluated is the performance of its funds. It is a common perception among investors that all is fine so long as the fund’s net asset value (NAV) is appreciating. However, there is much more that needs to be looked into.
For instance, while evaluating equity funds, the best way to find out if they have delivered, is by studying their performance over various time frames vis-à-vis both their benchmark indices and peers. Then the performance on risk parameters needs to be evaluated as well. The ability to deliver a well-rounded performance across time frames is the true test of a good fund house. Finally, it’s only in demanding market conditions, that the investment skills of a fund management team are truly tested.
In our view, investors should select a fund house whose schemes have consistently delivered on the risk and return parameters over longer time frames.
3. Area of proficiency
There are several fund houses in the mutual fund industry and nearly all of them offer a bouquet of offerings on both the debt and equity side. For example, on the debt side, the products range from liquid funds to long-term bond funds. Then on the equity side, categories such as large cap funds, small and mid cap funds, opportunities/flexi cap funds and thematic/sectoral funds are commonplace. Most fund houses have hybrids like balanced funds and monthly income plans in their arsenal as well.
Experience suggests that most fund houses develop expertise in managing funds of a certain category. For instance, some fund houses evolve into debt fund specialists. Then there are others that may develop expertise in managing large cap funds, while others may become proficient in managing mid cap funds. From an investor’s perspective, the key lies in recognising the fund house’s area of proficiency and then investing in line with the same.
While the above check list is not an exhaustive one, it can certainly be a starting point for investors in the mutual funds segment. Admittedly, selecting a fund house is easier said than done for investors. And this is where the financial planner/investment advisor needs to step in and play a vital role.