Picking The Right Mutual Fund

Understanding the kind of investor you are.

i)                           Risk profiling: Start by looking at what kind of investor you are-a technical term which explains this undoubtedly is ‘risk profiling’. Financial products and assets vary on basis of how much amount of risk you are ready to take to realize proportionate returns. Looking at it from the other side, ‘risk profiling’ suggests the measure of returns you are ready to forgo because you do not want to indulge into undue risk taking. Investors can broadly be categorized into conservative, moderate and aggressive. Risk bearing capacity typically depends on your long term goals in life.

RISK

Low                       Moderate       High

Low

Moderate     RETURN

High

ii)                          Goal of investing: This represents the main expectations you have from the subject investment. Broadly these could be:

a)      Do you have investible surplus which you want to invest to earn returns and do not need the returns for purposes already known to you? In such a scenario you would desire to invest in funds offering single time bulk investments and keep reinvesting all benefits- interest on bonds and dividends earned from equity investment to increase your corpus.

b)      Do you want to build up a specific corpus for specific points of time where you would prefer to invest in ‘cash payout’ type of investments where the payout coincides with that specific requirement in your life cycle. The time you decide to invest for is technically known to be your ‘investment horizon’.

c)       Or are you interested in investing to accomplish short term specific motives- tax saving and buying assets, otherwise out of your reach considering your current income and wealth.

Your goals of investing are typically influenced by the stage of life cycle and wealth cycle you are currently going through.

iii)                        Life cycle and wealth cycle: A typical investor would have the depicted kind of life cycle-wealth cycle combination. You style of choosing a mutual fund for yourself would depend on what kind of life cycle strategy you have for yourself and whether you want to go experience that point of inflexion in your life where after the transition phase, even if you undertake inter-generational transfers, the investment you made in the accumulation and the transition phases initiate bestowing such benefits to you in form of cash inflows so as to put-off your decline by a considerable number of years.

iv)                        Current capital base and regularity of income: In case your current capital base is at a will-be-able-to-absorb-all-risks level, and has descended upon you from sources which have least to do with your current flow of income, you are in fact been conferred with an additional chunk of investible surplus which would have been otherwise put aside for the rainy days. This free cash available with you induces your risk appetite to a level of being counted as an ‘aggressive investor’. In other cases, though, you would fall in moderate to low risk appetite categories and would always want to invest with caution, ready to experience lesser returns as a trade-off.

Regularity of your income comes into play when you start looking at the requirements of the mutual fund in terms of periodicity of investment required. You would typically choose ‘regular investment’ type of funds if you are regularly employed and single time bulk investments if you expect investible surplus to come to you at irregular intervals of time

Picking a category best suited to you

On basis of the category of investors you fit into, let us list down the broad categories of mutual funds available to you to pick from.

On a broader level, funds are either debt funds, equity funds hybrid funds or a else there could fall under the category of specialized funds.

Debt funds largely invest in debt products and securities are inherently low on risk and return but you, as an investor are sure to get what has been promised to you in terms of the interest returns. Debt funds include gilt funds, diversified debt funds, junk bond funds, fixed maturity funds, floating rate funds and liquid schemes.

Equity funds are generally suitable for more risk aggressive investors since the investments are high skewed towards stocks and so do not guarantee returns. Equity funds include diversified equity funds, sector funds, thematic funds, equity linked saving schemes (ELSS), dividend yield funds and arbitrage funds.

Specialized funds include gold funds, real estate funds, commodity funds, international funds, fund of funds and ETF (exchange traded funds). You would ordinarily invest in such funds if you believe in the glorifying appreciation of the subject investment or our personal beliefs and ethics are in line with considering some funds for investments and avoiding some others.

Picking a fund from within a fund category

Ultimate criticality arises when you are expected to make a precise judgement of choosing a fund from an endless array of possibilities available to you. It becomes a step of paramount importance when funds differ from each other only subtly. In such a scenario you would be required to study the softer aspects of funds to choose the fund which would most satisfy your desire of investing funds into such an avenue which would be opposed to innate human characteristic of not wanting to part from liquid assets.

The significant aspects to be studied can be enumerated in the following sequence:

i)                           Study the market reputation of the sponsor and the Asset Management Company. Find out as much as you can about the company’s growth and consolidation strategies to know whether they are in line with your long term growth and saving perspective. The credibility of the company and the promoters can be adjudged from the way strategizing is carried out and whether the concerned companies and business houses comply with the set norms of the industry and whether or not they are being able to follow the benchmark of discipline of the industry or not.

ii)                          Understanding the investment style of the fund manager is of utmost importance. Typical investment styles would be active v/s passive investment, growth v/s value investment and small cap v/s large cap investment. Study the promised investment style mentioned in the scheme information document and the fund offer document, and try to study the history of the fund manager to find out the events where the he did not act in coherence with the said style and the stimulating events for doing the same. The best fund manager is the one who does not undertake more amount of risk than desired by the unitholders so as to give them better returns. The investors have very carefully chosen the fund in wake of the amount of risk they would want to take and are well aware of the returns they would typically get.

iii)                        The historical returns and the track record reveals a lot about the kind of minimum returns you can expect to get even if an unexpected event of a reasonable degree occurs. The skewness and the peak of the graph should be studied to find out the broad fashion of returns and then you can build on your expectations on that basis.

iv)                        The fund offer document any other related documents are of huge importance when it comes to choosing the fund. The term goals and the technicalities should be in-line with our goals and expectations and this can only be adjudged if you study the fund offer document carefully.

v)                         Track the fund ratings of mutual funds on a regular basis. CRISIL gives three types of ratings to mutual funds; Capital Protection-oriented Fund Ratings, Credit Quality Ratings and Fund House Ratings. These ratings reflect the level of protection that a fund's portfolio holdings provide against losses from credit defaults. To maintain the rating at all times, the fund has to maintain a certain level of credit quality of the portfolio. Long-term ratings are assigned to open-ended funds (funds that do not have a defined maturity date) and to funds that have an original contracted maturity of more than one year. Short-term ratings are assigned to funds that have an original contracted maturity of one year or less.

vi)                        Expenses and charges also vary from fund to fund and these should be studied very carefully so as to know the gap between the stated NAV and the end amount you get.

vii)                      It is important to take fund age into consideration because a new fund with a lackluster of a fund manager with sound track record should definitely be avoided.