7 steps to selecting the right equity fund

Today, most Indian investors acknowledge the fact that equity mutual funds are one of the best and safer ways of creating wealth. However, equity mutual funds in themselves are a huge blanket category with quite a lot of variations to offer. It is a product where one size definitely does not fit all and neither does one size fit one person for every purpose either. At Moneyfront itself, we haveequity mutual funds from 26 AMCs! To aid you in selecting the right fund for you, make use of these seven steps to choosing the right fund:

1. Fund category

As per the SEBI re-categorisation circular of Oct 2017, today AMCs can offer equity mutual fund schemes only in 10 categories and hybrid funds leaning towards Equity in 3 categories apart from Fund of Funds and Index Funds. Each category has a specific investing purpose. For instance, dynamic asset allocation fund category within Hybrid funds is suitable for volatile times considering those funds rebalance at frequent intervals depending on the market scenario. On the other hand, Small Cap funds are best suited for long term wealth creation with a horizon of atleast 5-7 years. Check how different categories have performed over different periods using the Money Front Category Performance tool.

2. Sharpe Ratio

Sharpe Ratio is a technical number used to denote the return with respect to the risk being undertaken in the investment. For every one unit of risk, the number denotes the unit of return the fund is returning currently. So, if a fund’s sharpe ratio is 1.20, then the fund is giving 1.20 returns for the amount of risk you are taking. On the other hand, if the fund’s sharpe ratio is -0.30, then the fund could very well be giving negative returns for the risk taken. However, the ratio is a reflection of the market. When the markets do well, the risk does not seem very high or particularly giving negative returns. During volatile times, the sharpe ratio could point to more stable funds.

3. Expense ratio

Expense ratio is the percentage of investment charged by the fund house as cost of management. Each day, the expense ratio is calculated on the basis of the market value of the fund before deducting from it to express it in terms of NAV. Over the years, expense ratio can lead to much variation in the returns. Lower the expense ratio, better the returns. In that respect, one of the easiest things to do is to ditch Regular schemes of mutual funds which include in their expense ratio commissions given to brokers and opt for the cheaper Direct mutual funds which only includes the expenses of the fund house. Whenever you choose to look at the overview of a mutual fund through Money Front, the expense ratio is clearly displayed.

4. Past performance 

The old adage of “past performance is not a guarantee for future returns” still holds true. However, when you compare funds in the same category, past performance gives some idea of the relative historical trend for the fund. So, when you compare a few funds in a Mid Cap category, it is likely that a fund which has given returns of 20% over the last 5 years will continue to do better than a fund which has given maybe 12% over the same period. So, compare funds in the same category and take a call to decide which fund gives you more confidence. 

5. Turnover ratio

The turnover ratio refers to the amount and frequency of churning in the mutual fund portfolio. A figure of 1 means that the entire portfolio is churned in a year. Anything less than 1 means that there are some stocks held for more than a year whereas a figure of more than 1 means that all stocks are held for less than one year and the entire portfolio often changes in a period of less than a year. While mutual funds do not pay taxes on short term transactions, a higher turnover ratio is generally not favourable since the higher brokerage costs often eat into the returns and most stocks show good returns over a longer period of time. 

6. Vintage

Look for the launch date of the mutual fund. While the younger mutual funds might be able to show case high returns for the shorter period, the real worth of a mutual fund is reflected across longer periods. So, if a fund has shown superior performance over a 10 year period and maybe an average performance over a 3 year period, it might still be a safer bet to go for, rather than a fund which has shown superior returns over a less than 2 year existence.

7. Fund Manager

Mutual fund management is a specialised high skill task. It is also something people get better at with years of experience. Check for the fund manager of the mutual funds in consideration. Google him or her a little and see their experience as well as the past track record. 

While this consideration list might seem overwhelming, most of the information can be seen at a glance with Moneyfront and the decision can be easily made. When you invest keeping these points in mind, not only is the probability higher that you will choose right, but your confidence as an investor is also likely to see a spike. An educated investor already has the first step right. Happy investing!

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Pratik is an MBA from IBS business school – Mumbai, with dual specialization in Marketing and Finance. He is driven by passion for markets and loves to analyze client portfolios with a long-term approach. He believes in the principle of asset allocation and diversification to maximise client return following a risk-based approach. Managing risk comes naturally to him, owing to his prior work experience with worked for ICICI Prudential Life Insurance Co. Ltd.

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