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Three mantras to help you pick the best funds

Published on Mon, Sep 10, 2007 at 17:00 | Source : Moneycontrol.com

Updated at Mon, Sep 10, 2007 at 21:00

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A month ago, Mr Patankar (a cautious investor by habit) decided to invest Rs 3 lakh in a 'good' mutual fund.

He looked up the performance rankings of various funds, to try and zero in on the best fund. But a month later he is still confused, because there was no consistency or consensus amongst rating agencies.

Different financial web sites, magazines and newspapers came up with different conclusions as to the top rated funds.

This is because, the rating methodology adopted differs from agency to agency.

In a bid to prove that they are special and more incisive than the next agency, they adopt all kinds of techniques and statistical tools to come up with dissimilar results.

Why rankings differ?

Most agencies adopt risk adjusted ratings, however, the definition of risk differs from agency to agency.
Some adopt the Sharpe ratio, some use the Sortino ratio and yet others look at standard deviation and beta.
Then there are others who choose particular parameters like size of assets, portfolio turnover, tenure of the fund manager with the fund, fund size, expense ratio then proceed to assign weights to each of these parameters to arrive at a composite ranking.
Others declare that they use a proprietary system which remains unknown to the public at large.

So, how do you pick the best fund?

Here are three simple steps to sort out the good from the bad.

1. View rankings with a pinch of salt

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.

2. Ignore new funds on the block

If a mutual fund has been around for less than a year, ingnore it! Essentially - ignore one month, three month or six month returns and rankings. I will go to the extent of saying -- only look at those funds that have existed for over three 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.

3. Scout for common funds amongst various rankings

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.

Quick tips...

It is important that you invest in a well-managed fund, however, whether it is the top performing one or the second or the fifth, matters little.

Secondly, 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.

Just like Tendulkar having a lean patch doesn't make him a lesser batsman, don't get swayed by a three or six month performance number.

A good mutual fund stands the test of time, and this is the only true test.