A mutual fund is an investment option in the market. In a mutual fund, the investment amount is pooled in from various investors. Then the money is invested in a variety of underlying securities. In ratio to their investment amount, a mutual fund house issues unit of mutual funds to the unitholders.
If you’re investing in a mutual fund, remember to read the fund’s investment objective in the offer document. Profits or losses are proportionately distributed to the unitholders. Before it can collect funds from the public, mutual funds in India must be registered with the Securities and Exchange Board of India (SEBI).
Story continues below Advertisement
There are a plethora of mutual fund schemes available in the market. The question is - how do you know which is the right one for you? That’s why it is important to compare mutual funds. By applying financial ratios and other tools, you can analyze which mutual fund scheme is best suited to your investment goals.
Why should you compare mutual funds?
In the present market, an investor is completely spoilt for choices. There are a number of mutual fund schemes which look equally lucrative. However, as SEBI cautions always, investment in mutual funds should be done only after thorough diligence by the investor. Whether you are opting for short-term investments or long-term investments, it is important to ensure that you are getting the best returns. As an investor, you also don’t want to expose yourself to unnecessary risks. On a standalone basis, returns cannot be the sole basis of comparing two mutual funds. Investment decisions should weigh in all the important factors such as past performance of the fund, reputation of the fund house, risk assessment etc. In order to determine which mutual fund will actually check all these boxes, you need to compare mutual funds.
One of the most common ways of comparing mutual funds is by comparing the Net Asset Value of two funds. Usually, the NAV at the beginning and NAV at the end of period of time is taken into consideration by investors.
How to compare mutual funds?
Before you take the plunge and invest in a scheme, you need to understand your investment goals. You need to identify a fund that will provide for those needs. So you need to start looking at all the information available about a particular mutual fund you are interested in. Given the multiplicity of funds in the market, it is important to compare various mutual funds before you settle down on one. The following methods can be employed to compare mutual funds.
Benchmark
It offers a standard to evaluate the efficiency of a mutual fund. Benchmarks can show the returns the fund produced against how much it was supposed to deliver. As per SEBI regulations, each fund declares its benchmark and sees it as a performance analysis goal. If the index increases by 14 percent but the fund's NAV increases by 16 percent, the fund is said to have outperformed the index. Conversely, if the index drops by 12 percent but the fund loses by 14 percent, then it is said that the fund has underperformed the index. Using a benchmark as a tool of comparison helps to identify a fund which gains during good performance of the market.
Investment Horizon
The investment horizon of an investor is a key variable in the choice and comparison of funds. The investment horizon refers to the amount of time an investor stays invested in a given fund. The investor chooses to invest in a particular fund in line with his investment horizon. For example, if the investor is looking at a long-term horizon, the preferred choice would be equity funds. The investor should also have the necessary risk appetite for equity funds and its unpredictable returns. On the other hand, if the investor has a short-term investment goal (ranging from a couple of months to a year), liquid funds are a more suitable option. Liquid funds provide less but steady yields and are safer compared to equity funds. It is very crucial that the investment horizon and the funds to be compared match. You can compare the returns of two different equity mutual funds for a longer investment period, like 5 to 7 years. Similarly, while comparing two liquid funds, the investor should look at the returns of the past 6 months to 1 year period.
Story continues below Advertisement
Expense Ratio
The expense ratio is the annual fund operating expenses (such as administration, management, advertising etc.) of a scheme. It is expressed as a percentage of the fund’s daily net assets. To illustrate, if the expense ratio of a fund is 2 percent per annum, it means that each year 2 percent of the total assets of the fund will be used to cover expenses. As per the present regulations of SEBI, the expense ratio is fungible - SEBI has not imposed any limit on any particular type of expenses allowed, as long as the total expense ratio is within the limits prescribed by SEBI. The limits are as per the AUM of the mutual fund.
If the fund you are choosing to invest in has a very high expense ratio, you can expect the returns to be lower. Therefore, it is advisable to go for funds that have a lower expense ratio.
From 2013 onwards, SEBI has allowed investors to invest in mutual funds without the involvement of distributors. This is the direct plan of investment. Since there are no commissions involved in a direct mutual fund plan, the expense ratio is added back to the investments. This results in better returns for the investor and can make a difference in the long term investment goals of an investor.
It is advisable to compare funds that belong to the same category - for example, don't compare a direct plan with a regular plan; don’t compare index funds with an actively managed fund. Different types of schemes have different expense ratios; comparing two different baskets of mutual fund schemes (such as equity v. debt) will not help.
Type of underlying securities and industries
Mutual funds work by investing your money in a variety of securities. The investment is made in accordance with the investment objective of the fund. Each fund has to follow a certain mandate laid down by SEBI in this regard. For example, an equity fund has to necessarily invest at least 65 percent of capital allocated to equity shares of different companies. The underlying assets in which investments are made can affect the risk profile of the fund. But two funds of the same category need not have identical sector allocation.
Comparing funds on the basis of its sectoral allocation is a good idea. An investor should all times ensure that any investment decision made is in line with the risk appetite and investment horizon of the investor.
Risk factor
Every offer document says that mutual funds are subject to market risks. Therefore, any investment exposes you to some amount of risk. Depending on the type of scheme you choose, you can be exposed to very high-risk instruments or extremely low-risk instruments. One would assume that a high risk always means high returns. However, that is not a comprehensive assessment. This is where financial ratios like alpha and beta can help. Alpha is used to represent the value that a fund manager adds or deduct’s from a portfolio's return. On the other hand, beta is useful in telling the investor how much risk is involved in the investment.
Importance of comparing mutual funds
Mutual funds are one of the most popular ways to invest money in the market. It is a great option for new and experienced investors alike. Any investment can become a good investment when the investor understands the ins and outs of the offering. Unless the investment objective of the fund coincides with the investment goals of the investor, the investment will never be a successful one. Given the number of mutual funds in the market, it is easy to get swayed towards a fund because it looks attractive. However, that may be far from reality. That is why it is extremely important for investors to compare various mutual fund offerings before they decide to invest. Comparing funds helps an investor to map the choice of investment to his needs.
The investor should be absolutely satisfied before making an investment decision. When an investor compares mutual funds, he realizes the unique features of each offering even though they belong to the same class of investment. It also allows the investor to track the past performance of the funds, risk-assessment parameters and the expected returns. Since returns alone cannot decide which fund is worth investing, it is absolutely critical to compare mutual funds.
How to invest in mutual funds?
Investors can invest directly or contact the agents and distributors of mutual funds for necessary information and application forms. Investors must ensure that they invest through the Association of Mutual Funds in India (AMFI) registered distributors and that the distributor has a valid AMFI Registration Number (ARN).
For investments through the direct plan, the investor needs a financial adviser but does not have to pay any commissions to the distributors. This maximizes the returns from mutual funds. If the investment is done through a distributor, they are required to disclose all the commissions (in the form of trail commission or any other mode) payable to them for the different competing schemes of various mutual funds out of which the scheme is being recommended to the investor.
Investors also have the option to invest directly with the mutual fund either by visiting the mutual fund branch or online through mutual fund website. Forms can be deposited with mutual funds through the agents and distributors who provide such services. Another way to invest is to use the website of any online aggregator which sells mutual funds.
Before making an investment, the investor should take into account the track record of the mutual fund/scheme. Investors should also refer to the product labelling of the scheme. As per SEBI regulations, all the mutual funds are required to label their schemes on the following parameters:
- a) Nature of scheme – whether the aim is to create wealth or provide regular income in an indicative time horizon (short/ medium/ long term).
- b) A brief about the investment objective (in a single line sentence) followed by kind of product in which investor is investing (equity/debt).
- c) Level of risk depicted by a pictorial meter as under:
- Low - principal at low risk
- Moderately Low - principal at moderately low risk
- Moderate - principal at moderate risk
- Moderately High - principal at moderately high risk
- High - principal at high risk
Product labeling should be disclosed in:
- Front page of initial offering application forms, Key Information Memorandum (KIM) and
Scheme Information Documents (SIDs).
- Common application form – along with the information about the scheme.
- Scheme advertisements.
FAQs
I have invested in a debt mutual fund scheme. Can I change the nature of the scheme from debt to equity?
It is possible to change the nature of the scheme. However, SEBI has laid down certain regulations which need to be complied with for affecting such a change:
Any changes in the fundamental attributes of the scheme such as the structure, investment pattern, etc., can be changed only when written communication is sent to each unitholder and an advertisement is given in one English daily newspaper having nationwide circulation. The information should also be published in a newspaper published in the language of the region where the head office of the mutual fund is situated. In case the unitholders do not want to continue with the scheme, they have the option of exiting the present scheme at prevailing NAV without bearing exit load.
How can I know where the mutual fund scheme has invested the investment money?
As per SEBI regulations, every mutual fund has the obligation to disclose full portfolios of all of their schemes on a monthly basis on their website. Portfolio disclosure on a half-yearly basis is published in the newspapers. The fund house can also send the disclosure of half-yearly portfolios to their unitholders.
Out of the various types of mutual funds, which is the best one to invest in?
There is no size fits all approach to investment decisions. The investor should take into account the specific needs and the investment objectives before deciding. Information about various types of mutual funds is available online and in the offer document. It is advisable to read them carefully.
What is the difference between the NAV of a mutual fund and share price?
The share price represents the value of equity of a company as quoted on the stock exchange. The demand-supply and company’s projected performance has a bearing on the share price. This is why the market value and book value of shares matter. Book value represents the value of the company according to its balance sheet. On the other hand, market value is the value of a stock or a bond, based on the traded prices in the financial markets. That’s why the stock market price of a share is different from its book value.
However, in the case of a mutual fund, there is no market value for the mutual fund unit. Therefore, if the units of a mutual fund are purchased at its NAV, it is similar to purchasing it at its book value.
Do any liquid mutual funds provide guaranteed returns?
There are no guaranteed returns for any mutual fund investments. All mutual fund investments are subject to market risk. Therefore, it is important to read the offer document thoroughly to understand the risks of a mutual fund scheme.
Is there a time limit within which the proceeds of redemption of liquid funds are credited to the investor’s account?
Yes, it is usually done within 24 hours. In case of failure to credit the amount within the stipulated time period, the fund house is liable to pay interest as specified by SEBI from time to time for the period of delay. The delayed interest is 15 percent at present.
