Choosing the right MF to invest in

As writers and financial advisors, we have to routinely keep up with the performance and track record of various mutual fund (MF) schemes so that we can choose those that are suitable for the client’s profile and situation. However, it has been our constant experience that we just cannot find any consistency or consensus amongst rating agencies about their ranking of funds.

If you have been investing in mutual funds, perhaps you would identify with too. The bewildering thing is that given the same set of numbers, different finance magazines, websites, broker reports and newspapers come up with differing conclusions as to which are the top ranked funds.

The reasons for this aren’t far to seek. Essentially, the rating methodology adopted differs from agency to agency. In a bid to prove that they are special and more incisive than the next person, these agencies adopt all kinds of esoteric techniques and statistical tools to come up with dissimilar results.  As the saying goes, at the end of the day, numbers can be manipulated to get the results that you desire. So pure performance based analysis is only available in the minority.

Most adopt risk adjusted ratings — which would have been fine if only the definition of risk — or more precisely, the statistical tool that best defines the concept of risk was consistent. However, this too differs from agency to agency. Some adopt the Sharpe ratio, some use the Sortino ratio and yet others look at standard deviation, beta and alpha. Then there are others who choose some specific parameters such as size of assets, portfolio turnover, tenure of the fund manager with the fund, fund size, expense ratio etc. It does not end here.

They then proceed to assign weights to each of these parameters to arrive at a composite ranking. Yet there are others who declare that they use a proprietary system which remains unknown to the public at large. We can go on and on describing various different and sometimes downright amusing ways in which funds are being rated but by now you must have got the point.

So what should an investor do?
Well, the fact of the matter is that most of these arcane rating methodologies are solutions in search of problems. Don’t ignore them totally, however, when you go through them, keep your pinch of salt ready. Secondly, safely ignore all funds which haven’t been in operation for at least a year. Which essentially means — safely ignore one month, three month or six month returns and rankings.

We can go to the extent of saying that look at only those funds that have existed for over three to five years. Not only will you eliminate a whole lot of “me too” upstarts, but it will also give you an idea about the sustainability of the returns of the fund.  Now that you have significantly reduced the sample size, try and find the common funds that come up in the top ten lists of the various agencies. In other words, arrive at the lowest common denominator.

Remember, it is important that you invest with a well-managed fund; however, whether it is the top performing one or the second or the fifth matters little. Also a topper today may come in fourth next year and so on. As long as you have invested in a quality portfolio that has stood the test of time, the particular ranking from any particular agency should matter little.
To give you a cricketing analogy, you know Virat Kohli is a good batsman.

You don’t need anyone to tell you that. However, his rank amongst the leading cricketers will differ as per the agency calibrating the performance. So, who cares if Kohli is fourth, sixth or tenth? His performance over the years tells us that he is a good batsman and no one can argue with that. Now use the same principle while choosing your mutual fund investment.

And just like a Kohli having a lean patch doesn’t make him a lesser batsman, don’t get swayed by a three-month or a six-month performance number. Test of time is the only true test. Also note that the funds mentioned above are in the nature of examples – there are several other funds which are equally good and worth investing in.

Last but not the least
Even after having identified and invested in a good mutual fund scheme, there is one other vital thing that remains to be done. And that is you need to remain invested.  For example, the five year return of say Aditya Birla SL Equity is around 19.7 per cent p.a. To put it differently, Rs 50,000 invested in the scheme at this time in year 2013 would have been worth over Rs 1.23 lakh today.

By the way, the mention of the above scheme is just by way of an example. There are several other schemes which are just as good.  We must also hasten to add here that we are not suggesting that going ahead investors should expect similar returns. But for earning a return – any kind of return – holding the investment over long-term is imperative.

To sum
It is as simple to earn healthy returns from your mutual fund investments as it is not to. Just do the basics right, invest with established diversified schemes with a good track record and then hold on, hold fast and hold out. Let the money work hard and stay away from gimmicks. This way the chances of losing are virtually nil.

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