Understanding Mutual Fund Factsheet

By Nirmal Bang

The mutual fund sector is in the news of late owing to market regulator Securities and Exchange Board of India's focus on the performance of mutual fund (MF) houses in the present market conditions.

Interestingly, SEBI has made references to the role of distributors and increased the expense ratio to revive and resurrect the dwindling interest of distributors selling MFs. Therefore, it is just a matter of time before you come across a distributor selling a MF scheme, preferably equity. There could be situations where the investment pitch of distributors would be very convincing and promising. But as an investor you should be wary of a number of things.

Being an educated and prudent investor, you should read the fact sheet of the scheme to ascertain the authenticity of the investment pitch of the distributor. There are various details that succinctly capture the performance of a fund. These include the fund's investment objective, portfolio and changes in it, and essentially its performance in relation to its benchmark index.

Recently the market regulator found that nine fund houses' schemes had failed to outperform their benchmark indices and these fund houses are, therefore, being monitored by SEBI. In such a situation it is important that you be familiar with the fact of a fund before investing - because at times, selling a fund is the only motive and not necessarily selling the right fund

Understanding a Fact Sheet

THE OBJECTIVE

Most investors ignore this section under the assumption that all equity or debt schemes invest in the same manner. But investors miss the point in this assumption. The investment objective of a scheme could also inform about the risk the fund entails.

Depending on an aggressive or conservative approach, investors can make a decision about the period for which one should be invested.

There have been cases in the past when a fund meant to invest in the Futures and Options segment invested in fixed deposits. This is because the fund's objective is to go for capital appreciation. It has been observed that a number of large-cap equity funds invest in stocks that rally in uncertain markets.

These can be companies with medium-sized or small-sized market capitalization. Also, it has been observed that a balanced fund may increase its equity investment to cash in on the rally in the equity markets.

Hence, investors must read and sift through details of the investment objective and accordingly match its investments. Some funds may have substantial exposure to mid-cap companies, which means that it is a high-risk high-return fund, while some follow traditional conservative approaches of investing in large-cap companies, which are widely tracked and have strong revenue visibility.

Besides, investors should also compare the scheme with its peers in the industry. For this, there are web sites which help in providing in-depth detail about a fund's performance for a long period. These web sites have their own rating and methodology to recommend a fund. Also, these web sites, like newspapers, interview the fund managers of funds to provide an insight into the fund's investment strategy. Following these strategies can help investors to tide over any basic difficulty in investing in a fund.

PORTFOLIO COMPOSITION

Portfolio composition forms the most important part of a fact sheet of a fund. It is here that most investors choose to ignore since it is too technical and like patients who leave it to the doctor for proper medicine, these investors also leave the fate of the fund to a fund manager.

A portfolio composition generally includes two sections - the top 10 investments in terms of holding of the portfolio of the fund. A glance through the fund's composition reveals whether a fund has concentrated exposure to a particular stock or spread across investments, across sectors and companies. It is estimated that if top 10 stocks form over 40% of the net assets of the fund, then the fund is termed as concentrated fund. Otherwise, the fund is termed as a diversified fund.

One of the disadvantages of having a concentrated exposure is the uncertainty of market movements and earnings of companies. If certain companies fail to deliver the expected results due to some factors in the industry in which they operate or its inherent reasons such as the overall negative sentiment in the markets, then performance of the fund is jeopardized. Hence, it is important to have a well-diversified exposure.

Another major factor that investors need to keep in mind is sector allocation in the portfolio section. Again, having a diversified exposure to sectors serves the larger interest in securing reasonably good returns. There are cases in which companies which are fundamentally sound suffer due to sectoral issues. Hence, a concentrated sectoral exposure is not always a sensible option.

THE PERFORMANCE

It is obvious that performance of a fund is of importance especially for a long period of time. Longer a fund performs well, better are its chances of performing well in the future. This is the principle an investor should keep in mind while investing in a fund because an asset class like equities takes time to do well over a period of three years or more. Consistency in performance is the key.

Before gauging the performance of a fund, investors should keep in mind the concept of a net asset value (NAV) of a fund. Just like the share price of a company, the NAV of a fund functions as its share price. Hence, investors should follow the fluctuations in the NAV of a fund.

Apart from this, investors should also gauge a fund's performance with respect to its benchmark. Every fund follows a benchmark to give a relative picture to the investor as regards its performance with the broader markets. Hence, only if the fund has outperformed its benchmark over a longer period of time, preferably five years, then it makes a sensible investment option.

THE EXPENSES

Every fund has costs attached to it. One of these costs is the expense ratio. An expense ratio can be defined as the cost an asset management company incurs in operating a mutual fund. It has a bearing on the overall returns of the mutual fund. A fund's net asset value is declared after taking into account the expense ratio of the fund. Hence, high expense ratio can also reduce the overall returns of a mutual fund scheme.

To get a fair idea of the viability of a scheme, investors should compare with its peers, which have the same investment objective. A fund's scheme having a low expense ratio and same investment objective must be a lucrative option. But such funds can be considered only when their track record is consistently good.

Source: Nirmal Bang's Beyond Market