Our experience shows, a lot of investors rely solely on returns and go by the star ratings conferred on mutual fund schemes. But did you know there’s more to selecting a winning mutual fund than just this criterion?

Yes. Besides the above, there are many other parameters that need to be taken into consideration, such as:
 

• Risk a fund is exposed to;
• Average AUM and liquidity;
• Expense ratio;
• Portfolio characteristics;
• Investment processes & systems;
• ...and more!

 

However, effectively it is the qualitative parameters that add to the long-term investment objective of wealth creation.

Many invest in a mutual fund going by who’s managing the fund. But should there be this much emphasis on individualistic fund management?

We believe one cannot place much reliance on “star fund managers”, although they’re perceived to be the face of a mutual fund scheme. One needs to judge the investment processes and systems followed by the fund house, and assess if specified investment mandates are diligently followed by these respective fund managers.

In pursuit of generating exceptional alpha, fund managers indulge in trading or momentum playing, and sometimes even deviate from the investment mandate. Hence while you invest in mutual funds, pay close attention to portfolio characteristics – a qualitative aspect – that may help you identify this lacuna.

Here’s what you need to check...

The portfolio turnover – This will help you measure the frequency with which stocks are bought and sold, i.e. determine whether there’s too much churning in the portfolio. It will reveal whether the fund manager of the respective fund holds the portfolio with conviction towards the long-term fundamental portrayed by the security, or he’s indulging in mere momentum playing.

High or low turnover ratio cannot be an indicator of the fund’s performance. All it could do is give us a sense of how the fund manager is handling the portfolio. Thus, a higher portfolio turnover ratio does not necessarily mean higher returns; but on the contrary it could mean higher volatility. And mind you, excessive churning also leads to increased transactional costs borne by you, the investors.

An ideal portfolio turnover ratio should range between 50%-100%. More than 50% of turnover implies good amount of churning. But at times a higher turnover is also an outcome of fund’s strategy. For example, an opportunities style and growth style funds may demonstrate a high portfolio turnover ratio, as against value style funds.

A fund manager may face a conflict of interest between fund's objective and his personal objective. He/she may exploit market momentum to outperform. But he/she ideally should not be taking an over-advantage of information available in the market.

It is okay to be aggressive; however, the guiding factor behind it should be the investment mandate. Therefore, it becomes imperative to check if the fund manager’s actions are aligned to the investment mandate, which can also give us a sense of the risk that kicks in.

So, peep into the fund manager’s experience. Carl Sagan, eminent American astronomer, cosmologist, astrophysicist, astrobiologist, author, science popularizer, and science communicator has aptly said, “You have to know the past to understand the present.”

Since a fund manager is managing your money that’s invested in mutual funds, knowing his experience in fund management will be valuable. The fortune of the fund will be closely linked to the prudence with which he/she manages; and mind you, this is a function of the experience he/she carries in the field of fund management and equity research. One also needs to take a look at the research team that supports him.

To sum-up...
While you get lured by the starry performance of a mutual fund scheme and make fund managers stars or heroes, critically analyse the portfolio. As a litmus test, you also need to ascertain how the respective mutual fund schemes managed by the star fund manager have sailed during various market cycles (i.e. during bull and bear phases).

Instead of relying heavily on an individual’s fund management trait, it is vital that you give due weightage to the investment processes and systems followed by the fund house. Well laid out investment processes and systems, have a major impact of how individual mutual fund schemes perform, and moreover tend to sail well during the turbulence of the equity markets; as well as when the fund manager quits or retires from his job (this is because everything is defined as per the set investment processes and systems, along with the mandate which the respective funds follow).

Such an approach helps you reduce the downside risk, as investments made for the portfolio are process driven, where the investment mandates are followed by the fund houses, and the fund manager's role is to function within the parameters defined by the fund house.
 

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