What should you look for in an equity diversified fund?

Gopal Agrawal, Chief Investment Officer, Mirae Asset Global Investments

For most of us, zeroing in on an equity diversified fund means to choose those funds which are placed higher up the ranks on the basis of past performance. Even while this seems to be a simple exercise, in reality one encounters a situation wherein fund performances fluctuate over time.

Also, investing in the best performing fund is like driving while seeing in the rear view mirror since as the disclaimer goes 'Past performance is no guarantee of future results.' In this article, Gopal Agrawal helps you to pick the right equity diversified mutual fund based on some simple but extremely important parameters.

1. Investment objective
Akin to your investment objective, every mutual fund scheme has an investment mandate or the boundaries within which the fund manager can craft a universe of stocks. It is extremely important that your investment objective is in sync with the fund's investment objective. E.g. if you are an investor who prefers to avoid risk, it would not be prudent for you to invest in a small cap fund that invests in small size companies and can display high volatility in terms of returns.

2. Risk adjusted returns
The absolute returns delivered by a mutual fund are one of the most common ways to evaluate its performance. However, this may not be a prudent way to judge the scheme since it does not take into account the risk associated with the investment. A mutual fund manager may be able to generate impressive returns by taking risky bets which if gone wrong can lead to a drastic fall in its performance and hence loss of wealth for the investor. Hence it makes more sense for you to consider the returns in relation to the risk associated with the investment. There are some simple but effective ratios available that focus on the risk-return profile of mutual funds.
• Alpha:  it is a measure of the fund's performance on a risk-adjusted basis. Alpha takes the volatility (price risk) of a mutual fund and compares its risk-adjusted performance to benchmark index. The excess return of the fund relative to the return of the benchmark is the fund's alpha.

• Beta: Also known as the 'Beta coefficient', it is a measure of the volatility of a mutual fund scheme relative to its benchmark index. You can think of it as the tendency of your fund's ability to respond to swings in the market or its benchmark index. If you consider the above two ratios in tandem, youwill realize that it makes sense to invest inthose funds that generate high alpha albeit at lower (<1) beta.

• Standard deviation (SD): This parameter measures the volatility of returns. For this, one needs to calculate the average return generated by the scheme for a given period and then measure the dispersion from this mean. Higher the dispersion, greater the standard deviation which implies a high volatility fund. Hence conservative investors should choose funds with lower standard deviation

3. Track record of the fund house
When it comes to new fund launches, there is no track record to evaluate. Under such circumstances, one can look at the performance of other funds managed by the same asset manager to acquire a sense of its credentials. In fact, it is wise to follow this approach even for an existing investment to avoid fund performance aberrations wherein only a single scheme has been doing well.

4. Fund corpus
Investors tend to focus on large corpus funds given that they offer the comfort that the fund is well-accepted. However, large funds may sometimes be at a disadvantage. Consider this example, a large sized mid-cap fund would find it difficult to sell a stock of a small company since there may not be enough liquidity in the market for the same. Similarly, such a fund placing an order for a mid-size stock with limited liquidity will find it difficult to do so compared to a relatively smaller size fund.

5. Fund ratings
Among the recent developments in mutual fund evaluation is the availability of comprehensive fund performance ratings,wherein reputed ad credible agencies (domestic and international) conduct a detailed performance analysis of funds on parameters like risk adjusted returns, portfolio composition, asset concentration, liquidity etc. The agency then assigns a specific rating (e.g. 5 star for high performing funds to 1 for poor performing funds). You can take advantage of these ratings conferred to funds by agencies like CRISIL, Value Research, Morningstar, Lipper, ICRA etc. to finalize your preferred mutual fund investment.