Well, this is true because the performance of mutual funds depends on the performance of the stock market. This is because the amount we invest in mutual funds is ultimately invested in the stock market by the mutual fund houses.
So, if you are neglecting the performance of a mutual fund before buying, you may be doing the wrong thing. It is very important to do a performance evaluation of mutual funds so that you can make informed decisions before making any kind of investment.
Also, it must be noted that the past performance of mutual funds does not indicate the future performance of a fund. One cannot expect guaranteed returns on mutual fund investments. Hence, it has become important to look beyond the returns of previous years to assess a mutual fund.
Another question that may come across your mind is how frequently one must assess a mutual fund’s performance. Ideally, one should do a performance evaluation of mutual funds in every four to six months. If you feel that all the research and analytics are just too time-consuming for you, you can always take advice from a professional financial advisor who will guide you on the right path.
Let us have a look at some of the top few measures to evaluate the performance of a mutual fund –
1. Alpha
Alpha refers to the financial ratio that depicts the returns generated by the mutual fund over and above the returns generated by the benchmark index. The Alpha value of 0 indicates that the fund has performed in line with the benchmark. A negative Alpha value means that the fund has underperformed as compared to its benchmark. On the other hand, a figure above 0 means that the fund has outperformed.
For example- If a mutual fund generates a return of 12% per year and the benchmark index grows at 9%, the Alpha value, in this case, would be 3.
Thus, the Alpha value is considered to be a measure that indicates the value that a fund manager adds or subtracts from a portfolio’s returns. Also, it must be remembered that your fund’s Alpha value must be higher than the peers, which are at a similar level of Beta.
2. Beta
Another statistical measure used in the performance evaluation of mutual funds is Beta. Beta value shows the tendency of a portfolio’s return to fluctuate as per the market movements. A beta value of 1 indicates that the mutual fund is as volatile as its benchmark and a Beta value above 1 means that the fund is more volatile. A value below indicates that the fund has reacted lesser than its benchmark.
3. Expense Ratio
The expense ratio basically means the fee charged by the mutual fund houses for managing your mutual fund. It includes management fees, distribution fees, transaction charges and various other charges.
Essentially, the expense ratio may seem small to you in the beginning but over time, you realize that you have ended up paying a huge sum from your corpus towards the expense ratio. Since this ratio impacts your take-home returns, it must be considered carefully while doing a performance evaluation of mutual funds.
4. Do a Comparison of Similar Funds
Comparing two different funds is a futile exercise. Hence, one must compare mutual funds of similar categories and study various aspects like the risk and historical returns of the mutual fund. To do this, systematically, one can make a list of comparable funds and compare them on a regular basis. Various free mutual fund screener tools are also available online and can be used to study peer funds.
5. Rolling Returns
Rolling Returns refer to the average annual returns for a given timeframe with returns taken into account till the last day of the duration. It also shows the relative and absolute performance of the fund at regular intervals.
Rolling Returns are an effective way of measuring how the fund performed during the entire duration.
6. Sharpe Ratio
Sharpe Ratio shows the amount of extra revenue received for the additional risks undertaken by you. The underlying idea is that higher risks must give high rewards. Also, investors deserve a reward for the market volatility and Sharpe Ratio indicates how much the reward should be in such cases.
7. Consider Market and Economic Cycles
It is essential to consider external factors like market and economic cycles while evaluating mutual funds because these aspects are majorly concerned with the actual performance of mutual funds. Assessing only internal factors is not enough because a thorough analysis of all the other factors determines how the mutual funds will perform in the future.
For this, it is best to consult with investment advisors so that they can guide you about the external factors that impact mutual funds’ performance.
Conclusion
The aforesaid parameters can help one in assessing the mutual fund performance and finally selecting the right funds. Also, after choosing the right funds, one must keep tracking its performance periodically to ensure that it is the right choice according to one’s investment goals and risk tolerance.
One can pick the best mutual fund depending on the investment horizon and select the best mutual fund scheme that can help you in creating wealth.
To learn more about mutual funds investments and performance evaluation of mutual funds, connect with mastertrust.