This part of MF Classroom aims to ease the process of selecting the right fund to invest in.
Part 6 of the Classroom series on mutual funds explains how to go about selecting the right fund to invest in, what are sectoral funds and the pros and cons of investing in them, among other things.
Q. How do I select a mutual fund? Can I go by past track record alone?
A. Choosing a mutual fund is an involved process. As mentioned earlier, you must first decide what target you are saving towards. Then, the time horizon to the goal, your risk appetite and investible surplus, all play a role in making the right fund choice. If you aren’t clued up to the markets and mutual funds, it would be ideal to take the help of a financial advisor.
Past returns of a fund can only be a starting point for your fund-choosing process. A scheme may or may not replicate its track record of the previous years in the future.
So, you must take into account the consistency of a fund – how it manoeuvres the gyrations during market rallies and steep corrections. Is it able to contain downsides during declines and participate well during market rallies? Does it consistently beat its benchmark and category? Does the fund hold a concentrated portfolio or is it well-diversified? Has the fund manager been around taking care of the fund for a long enough period? Does she stick to the fund mandate religiously without deviating?
The answers to these questions will determine the right fund to pick.
Q. Is it a good idea to book profits at regular intervals?
A. Not necessarily! When the profits compound over the years, you are likely to have a substantial sum saved up. Having said that, if you need the money or if you are highly risk-averse, you can probably take some profits off the table. Also, if you feel that during a specific period the markets have rallied too massively for your comfort and that a correction is likely, you can book some profits.
In the ideal course of things, you need to book profits only if you reach a financial target ahead of the expected time and want to play safe.
Profit booking is more for equity traders and is usually not applicable so much to mutual fund investors given that a scheme holds a portfolio of stocks with varied prospects and those that rally at different points in time, not necessarily simultaneously.
Of course, if you follow a systematic transfer plan, wherein you take profits off debt funds and move them to equity schemes, you can book profits at regular intervals.
Or, if you are a debt fund investor dependent on MFs for regular income, you may have to book profits regularly.
Q. What are sector funds? What are the pros and cons of investing in them?
A. Sector funds, as the name implies, invest in specific industry segments. Examples could be technology, IT, pharma, banking and infrastructure. So, an IT sector fund would invest only in the shares of software companies, a pharma fund would invest in the stocks of pharmaceutical firms and so on.
For sector funds, the timing of entry and exit while investing becomes important to gain from any rally in the stocks of a specific segment. A diversified equity fund, on the other hand, invests in a basket of varied industry segments and hence can be invested in at any point in time.
Also, in a sector fund, you need to be aware of the fortunes of the segment – when it bottoms out in a market cycle when the stocks in the category rally and so on.
Thus these funds require constant monitoring.
The advantage, if at all, in investing in such sector funds is that they could make disproportionate returns in case the stocks in the segment rally massively and outperform other industries in a positive market cycle.
On the other hand, if the segment is out of favour, stocks in the sector could be decimated and funds investing in them could face serious erosion in their NAVs.
Retail investors may be better off sticking to diversified funds.
Q. Should I go for a dividend scheme or a growth scheme?
A. You must understand that dividends are given in mutual funds from your own investments. Once a fund, equity or debt, declares a dividend, it is deducted from your NAV and given to you. There is also no certainty of the dividend option of a fund declaring dividends regularly.
Dividends in MFs are not like those in companies where a company shares its profits with the shareholders.
Unless you need some cash flow from investments, is better to stick to the growth option. There are tax implications for dividends as well, especially in the case of debt funds.
Q. If the fund manager of a scheme that is performing well quits, should investors be worried?
A. Investors needn’t worry immediately, but they do have to turn a bit more watchful with the fund.
After a fund manager quits, you have to take note of whether the asset management company makes any changes to the fund mandate itself. You should also take note of the credentials of the new manager.If after the new fund managers take over, in a period of six months to one year, the fund’s performance drops and lags its benchmark and peers, you should probably first stop SIPs and if the underperformance still persists for longer, shift to a different scheme.Get access to India's fastest growing financial subscriptions service Moneycontrol Pro for as little as Rs 599 for first year. Use the code "GETPRO". Moneycontrol Pro offers you all the information you need for wealth creation including actionable investment ideas, independent research and insights & analysis For more information, check out the Moneycontrol website or mobile app.