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Mutual Fund Selection – Six Key Technical Factors to Consider!

A study of Technical Factors involved during Right mutual Fund Selection: Mutual Fund as a financial product has gained a lot of dominance in recent years. With the growing education of financial products and government advertising schemes like ‘Mutual Fund Sahi hai”, people are now more aware of the various mutual fund investment avenues.

In our previous article on how to pick a mutual fund, we had given insights on the various fundamental factors, we should consider and understand before selecting a Mutual Fund to invest. Through this article, we aim to look at and explain the various technical factors that need to be considered for mutual fund selection. Thorough knowledge of both fundamental and technical factors goes a long way in picking the right funds to invest in.

Anyways, before understanding the technicalities, let us revise the concept of Mutual funds to brush up our basics. Let’s get started.

What is Mutual Fund?

mutual funds trade brains3

To put it in simple words, a Mutual fund is a pool of money which is been collected from various investors who want to invest their money in the stock market and other profitable assets but do want to go through the whole process of selecting the avenues to invest. They just park their money with a Financial Institution (in this case AMC), which in turn takes on the mantel of investing the pooled fund and generate returns for investors.

The funds are being managed by the fund managers, who use their skill and experience in generating the best possible returns for the investors. Eventually, these returns are sent back to the initial investors, after deduction of the basic costs required to run that fund.

Technical Factors to consider for Mutual Fund Selection

Here are six of the most important technical factors that the investors need to consider for mutual fund selection. Anyways, the best part about these technical factors are they are very simple to analyze. Let’s look into these technical factors:

1) Expense Ratio

This probably is one of the most important factors that is sometimes overlooked a few investors while deciding upon a mutual fund.

The expense ratio is the fee that is charged by the Asset Management Company (AMC) for managing the mutual fund. It basically includes the fee the fund manager, other operational and administrative expense which are incurred while managing the fund. Expense cost is charged on a year to year basis.

Generally, the expense ratio is also the function of the size of the fund. The type of Mutual funds (Growth and Direct) also impacts the expense ratio. The expense ratio of Direct mutual funds is lesser compared to Growth mutual funds.

In India, the expense ratio generally varies between 1% to 2.5% of the total fund value, depending on the fund house and type of fund.

2) Fund’s Portfolio

This is one very important consideration while buying a mutual fund. With the help of careful analysis and research, we can choose the fund which has a portfolio that suits our risk profile. And even the size of the portfolio makes a lot of difference in choosing a mutual fund.

Say, if we were to choose a blue-chip fund to invest. A fund that has diversified investment in 50-60 stocks, is more likely to perform in line with the performance of Nifty, and the fund which had a smaller portfolio is likely to have more volatile returns.

The quality of shares in the portfolio also makes a difference in the performance of the fund. The fund which includes sector leaders has more sable returns compared to one that is laggards of the industry.

3) Rating Agencies

The rating given by rating agencies provides valuable insight into the performance of the funds. For example, CRISIL Ratings of different mutual funds. Just to put in perspective, a rating of 5 on 5 generally means the fund has been performing better than expected in their category. They have been managing risks that are well within the acceptable limit. While rating a fund, the historical performance may be given higher weightage by different rating agencies. It a basically a consistency parameter of the mutual fund.

4) AUM (Asset Under Management)

The total value of the assets which are being managed by the fund (AUM), gives a big picture of the quality of the fund. The fund which has a large AUM has a faith of a large number of investors which in turn gives an indication that it is managed in a professional and cordial manner. And these funds are managed by professional Fund Managers. The following are some of the factors which have an impact on the AUM of the fund:

  • The Fluctuations of the market
  • The performance of the fund i.e., if the fund performs well, then the AUM of the fund increases and it attracts more investors to put money in the fund.
  • Size of the fund. If the fund is of big size, then the returns generated will be higher which in turn will increase the size of the AUM of the fund

5) Category Returns

One’s performance is always judged by how they perform compared to their peers. Similarly, in the case of mutual funds, the performance of the funds, compared to their category peers holds a lot of significance.

Again to take the example of Bluechip Funds:blue chip fund category returns

Figure : Mutual funds peer comparison (www.moneycontrol.com)

Now, if we look at the figure above, we see the performance comparison of the Blue chip funds category. And the categorical comparison helps us in understanding the fund’s performance. There are various parameters to choose from. And one can filter the funds, depending on one’s preference, and make an informed judgment while buying the fund.

6) Risk Ratios

The last on the list, but one of the most important parameters in judging the funds’ performance. The risk ratios help us in understanding the risks taken to generate returns for the investors. Through this article, we will have a look at the two risk factors: Standard deviation & Beta.

Standard Deviation (SD): This parameter judges the volatility of the fund over the last three years. If the SD value is low, it generally indicates low risk and low volatile funds and which ultimately leads to more predictable performance. Therefore, if we have two funds, Fund A and Fund B. If both the funds are giving similar returns, and if one has a lower standard deviation than others, then it is advisable to choose a fund with a lower standard deviation.

Beta: Even beta is used to understand the volatility of the fund. If the fund had a high beta, then the funds is generally more volatile. It is advised to choose funds that have low beta value.

Even while doing the risk analysis of the category of the funds, the ones which have low beta and standard deviation should always be the preferred choice.

Conclusion

In this article, we tried to cover the technical factors that you should look into during mutual fund selection for right investments. Here are the top takeaways from this article:

  • A clear understanding of both technical and fundamental factors goes a long way in choosing the right fund to invest.
  • The size of the fund along with portfolio diversification should be given due importance in choosing the fund
  • The expense ratio gives information about the cost of managing the fund. The lower the expense ratio, the higher the returns for the investors.
  • The categorical comparison helps in selecting the right fund which matches one’s risk profile
  • The risk factors that measure the volatility of the funds should be carefully analyzed and the fund with low volatility should be preferred while investing.

That’s all for this post. I hope this was helpful to you. If you’ve got any queries related to the above-discussed factors for mutual fund selection, feel free to comment below. I’ll be happy to help. Happy Investing.

How to Pick a Mutual Fund?

How to Pick a Mutual Fund? A Beginner’s Guide.

How to Pick a Mutual Fund?

Are you a financial newbie and just learning to pick things piece by piece? Don’t worry; you are in the right direction. Considering you are here, reading this article, you are one step ahead.

Now, let’s quickly clear all your queries associated with picking the best deal out of many. Needless to say, investing in a mutual fund is a matter of lacks of rupees and sometimes a matter of crores, one needs to be very deterministic while picking out the best suitable option. When we say “best”, we are doing two things, mainly.

  1. Evaluating different options for mutual funds.
  2. Comparing those with their past (historical) records.

A good head start, therefore, can be done by self-evaluating the needs. In layman’s terms, what are you planning to achieve after you get an access to your matured fund?  – Housing? Marriage? Home Development? … Or Education? 

While the reason can vary from a person to person, the risk-bearing also does.

To explain it better, if you’re planning to clear your debts with the matured amount, you can’t tolerate greater risks associated with your fund. That’s the reason for taking the end goal into clear consideration. Further, in this article, let us know what all you need to know to pick the best possible option for a mutual fund. Stay tuned!

1. Get Acquainted with Risk Tolerance:

Clearly, the objective or end goal does alter the consideration of “Risk Tolerance” moreover; it helps you know how much risk you can sustain in your portfolio. Personally, if you can’t toleration too much of underperformance in your portfolio then picking out highly volatile mutual funds is not an option for you.

What exactly is risk tolerance? – It is explained as the amount of deviation (negative) associated, from the expected returns on an investment which an investor can withstand.

Since mutual funds are influenced by the movement of the market, one can’t accurately predict the happenings but estimation never hurts. However, there’s a quick math for you to remember “maximum risks = maximum returns”. But the question is again, “can you sustain it?”

Pro Tip: Aggressive Risk Tolerance (ART) understanding can help various high scaled investors to put their chances on portfolios with super high risk.

On the other hand, Conservative Risk Tolerance (CRT) does give a little to no scope for a risk to penetrate into a portfolio.

Also read: How to Measure Risks in Mutual Funds?

2. Know about Different Fund Types: 

There are several types of Mutual Funds in the market. In fact to count in all 4 directions of the world, one has 8000 choices to make for mutual funds. But it again comes down to one single point – the end goal.

  1. If your needs are for the longer term and you can sustain risk, you can choose the capital appreciation funds. As mentioned, the risk associated is on the higher side but given that, the growth of return is also magnificent.
  2. If your needs are to be catered for a shorter term with minimal risk, you can go for the income funds. The income funds give you a stable return with a realistic percentage. What’s the advantage? – Minimal to no risk.
  3. If your needs are for the longer term, however, you don’t want any risk to be associated with your portfolio, balanced funds are the best choice you. Sure, the return wouldn’t be magical but you can get the benefit of “long-term investment” and can minimize the question of risk as much as possible.

There are several more types of funds to be explored in the market. Choose the one that you think is best suitable for your end goal.

3. Know about the charges and fee structure: 

When you purchase a mutual fund, you have to pay a charge or fee initially or when the shares are sold. In both the cases, the fee is known as a load.  

The load can be further classified into

  1. Front-end load – When you have to pay the fees initially while starting a mutual fund for yourself.
  2. Back-end load – When you have to pay the fees when you sell your shares in the fund. (Generally, a Back End Load is applied if you decide to sell your shares before a specific time period, say 7 years of purchase). This limits your activities of “share selling”.)

Administrative charges are another kind of charges that are associated with an investment. The administrative charges are charged by an insurer mainly for record keeping or t=other important administrative facilities given on an investment.

What do you need to keep in mind? – Make sure to read the literature of Mutual Fund before & after purchasing it to keep track of administrative charges, management expense ratio, and other charges. This will help you clear all the hidden complexities about the return on investment.

Also read: Best Mutual Funds in India -Policy Bazaar

4. Evaluate Past Trends and Fund Manager’s Activities:

The final but very important step is to bring in the case of historical data. When it comes to a prediction, historic data helps in backing up the decisions.

When it comes to evaluation, let’s quickly know what pointers to keep in mind:

  1. What are the previous results that a Fund Manager has managed to deliver without a fail?
  2. Does the past trend show that the portfolio is extremely volatile under specific conditions?

Peeking into the literature of a fund manager can help you with this case, mostly. Also, taking an expert advice is always recommended for better decisions.

Lastly, you must know that in the market, the history does not (read never) repeats itself. That is, don’t rely blindly upon the past data without bringing in the possibilities for future prediction. Both the cases help in their own way when it comes to mutual funds. A little research with a proper guidance can take you one step forward to your end goal (high return on your investment) – that’s the bottom line.

Also read: What Would You Rather Have: Rs 10 Lakhs Right Now or 1 Paise Doubled Every Day For 31 Days?