- Date : 18/10/2020
- Read: 6 mins
Here are some parameters that you need to keep in mind while choosing a mutual fund scheme.
With 42 mutual funds and close to 2000 open-ended schemes, choosing a fund for investment can be a daunting task. To make this process a little easier for you, we have compiled a quick checklist that you can refer to before selecting a scheme.
Scheme category
Post SEBI rationalisation, all schemes have been bifurcated into 10 equity funds, 16 debt funds, 6 hybrid funds, 2 solution-oriented funds and 2 schemes falling in ‘others’ category. For every category, SEBI has a well-defined asset allocation. Hence, you can broadly understand where the scheme will invest by simply looking at the scheme category. This will simplify your shortlisting process based on your needs.
Here is a table summarising the asset allocation for each category of equity fund:
|
Equity fund |
Portfolio construction |
|
Multi-cap fund |
At least 65% exposure across market capitalisation |
|
Large-cap fund |
At least 80% exposure to large-cap stocks |
|
Large and mid-cap fund |
At least 35% exposure to large-cap and 35% to mid-cap |
|
Mid-cap fund |
65% exposure to mid-cap stocks |
|
Small-cap fund |
65% exposure to small-cap stocks |
|
Dividend yield fund |
65% exposure to dividend yielding stocks |
|
Value fund and contra fund |
65% stocks in value theme or contra strategy respectively |
|
Focused fund |
65% on focused strategies |
|
Sectoral/thematic fund |
80% exposure in a particular sector and thematic sector |
|
ELSS |
80% in equity instruments |
Understand if the scheme is true to its category
While SEBI has put in place minimum asset allocation requirements across different schemes, there is still a degree of freedom available to fund managers. For example, in large-cap funds minimum 80% of investments need to be made in large-cap stocks while the remaining 20% can be invested across market capitalisation and debt; the minimum mid-cap investment requirement for a mid-cap fund is even lower at 65%.
This means you cannot rely on scheme category alone. You need to look at the portfolio market capitalisation to understand how closely the scheme aligns to its mandate.
Historical performance
While past performance is not an indicator of future returns, it helps you understand how effectively the fund manager has performed across market cycles. In that sense, scheme returns need to be checked in conjunction with the time for which the fund manager has been heading the scheme. If a new fund manager has recently joined the scheme, you need to evaluate the scheme for some time to understand how well the new fund manager is managing the scheme.
Rolling returns
In addition to historical performance, you need to analyse the long-term rolling returns of the scheme. Rolling returns give a better idea of scheme consistency by calculating continuous returns over long periods. You can use this data to get guidance on the average performance of the scheme and understand the variance in performance. Rolling returns help you understand return variance by calculating the minimum and maximum returns during the period.
Duplication in investment
You may observe that top holdings across schemes tend to be similar. This increases investment duplication risk. Thus, if you are already investing in a category, e.g. large-cap fund, do not invest in another large-cap fund. Additionally, before making an investment, check the degree of similarity between your existing portfolio and the prospective investment.
To elaborate, if your prospective scheme has exposure to stocks that are also present in your existing mutual fund investments, you need to decide whether it makes more sense for you to invest in another scheme.
Portfolio turnover ratio
This is an important parameter, which indicates if the fund manager invests in stocks with a long-term view. A high turnover ratio is indicative that there’s been a portfolio overhaul in the last one year. A low portfolio turnover ratio, on the other hand, shows that the fund manager follows a buy-and-hold strategy. Moreover, high portfolio turnover ratio results in higher transaction and trading costs, which impacts scheme returns.
Anita Sutrave is Deputy CEO at Cafemutual. She has been actively engaged in the knowledge enhancement of the financial distribution community. She is a travel enthusiast and loves reading. She can be reached at anita@cafemutual.com.
With 42 mutual funds and close to 2000 open-ended schemes, choosing a fund for investment can be a daunting task. To make this process a little easier for you, we have compiled a quick checklist that you can refer to before selecting a scheme.
Scheme category
Post SEBI rationalisation, all schemes have been bifurcated into 10 equity funds, 16 debt funds, 6 hybrid funds, 2 solution-oriented funds and 2 schemes falling in ‘others’ category. For every category, SEBI has a well-defined asset allocation. Hence, you can broadly understand where the scheme will invest by simply looking at the scheme category. This will simplify your shortlisting process based on your needs.
Here is a table summarising the asset allocation for each category of equity fund:
|
Equity fund |
Portfolio construction |
|
Multi-cap fund |
At least 65% exposure across market capitalisation |
|
Large-cap fund |
At least 80% exposure to large-cap stocks |
|
Large and mid-cap fund |
At least 35% exposure to large-cap and 35% to mid-cap |
|
Mid-cap fund |
65% exposure to mid-cap stocks |
|
Small-cap fund |
65% exposure to small-cap stocks |
|
Dividend yield fund |
65% exposure to dividend yielding stocks |
|
Value fund and contra fund |
65% stocks in value theme or contra strategy respectively |
|
Focused fund |
65% on focused strategies |
|
Sectoral/thematic fund |
80% exposure in a particular sector and thematic sector |
|
ELSS |
80% in equity instruments |
Understand if the scheme is true to its category
While SEBI has put in place minimum asset allocation requirements across different schemes, there is still a degree of freedom available to fund managers. For example, in large-cap funds minimum 80% of investments need to be made in large-cap stocks while the remaining 20% can be invested across market capitalisation and debt; the minimum mid-cap investment requirement for a mid-cap fund is even lower at 65%.
This means you cannot rely on scheme category alone. You need to look at the portfolio market capitalisation to understand how closely the scheme aligns to its mandate.
Historical performance
While past performance is not an indicator of future returns, it helps you understand how effectively the fund manager has performed across market cycles. In that sense, scheme returns need to be checked in conjunction with the time for which the fund manager has been heading the scheme. If a new fund manager has recently joined the scheme, you need to evaluate the scheme for some time to understand how well the new fund manager is managing the scheme.
Rolling returns
In addition to historical performance, you need to analyse the long-term rolling returns of the scheme. Rolling returns give a better idea of scheme consistency by calculating continuous returns over long periods. You can use this data to get guidance on the average performance of the scheme and understand the variance in performance. Rolling returns help you understand return variance by calculating the minimum and maximum returns during the period.
Duplication in investment
You may observe that top holdings across schemes tend to be similar. This increases investment duplication risk. Thus, if you are already investing in a category, e.g. large-cap fund, do not invest in another large-cap fund. Additionally, before making an investment, check the degree of similarity between your existing portfolio and the prospective investment.
To elaborate, if your prospective scheme has exposure to stocks that are also present in your existing mutual fund investments, you need to decide whether it makes more sense for you to invest in another scheme.
Portfolio turnover ratio
This is an important parameter, which indicates if the fund manager invests in stocks with a long-term view. A high turnover ratio is indicative that there’s been a portfolio overhaul in the last one year. A low portfolio turnover ratio, on the other hand, shows that the fund manager follows a buy-and-hold strategy. Moreover, high portfolio turnover ratio results in higher transaction and trading costs, which impacts scheme returns.
Anita Sutrave is Deputy CEO at Cafemutual. She has been actively engaged in the knowledge enhancement of the financial distribution community. She is a travel enthusiast and loves reading. She can be reached at anita@cafemutual.com.
