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?
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.
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.
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.
Hitesh Singhi is an active derivative trader with over +10 years of experience of trading in Futures and Options in Indian Equity market and International energy products like Brent Crude, WTI Crude, RBOB, Gasoline etc. He has traded on BSE, NSE, ICE Exchange & NYMEX Exchange. By qualification, Hitesh has a graduate degree in Business Management and an MBA in Finance. Connect with Hitesh over Twitter here!