Investors calculate the mutual fund’s performance – its growth over the years – to select a mutual fund for investing. Mutual fund companies exhibit metrics like the growth of their asset under management (AUM) and fund flow as their business strength to attract investors. But these metrics offer very little insight into the actual business performance of the company against its peers and can impact the investor’s ability to make an informed decision.
So, how do you evaluate the current performance of a mutual fund firm? According to a study on assessing mutual fund companies performance, the writer argued that market share and change in market share are more efficient metrics to evaluate the company’s performance.
Parameters To Analyse Mutual Fund Performance
- Fund vs benchmark
Benchmark is an index or an aggregation of securities that represents the market or a specific sector. Comparing your selected mutual fund with the benchmark is one of the prominent aspects of analysing the mutual fund’s performance.
An optimum mutual fund should be able to match the performance of the benchmark over long periods of time. Apart from comparing the longer tenure, an investor must look for the performance of the fund over multiple time frames – whether it is outperforming or underperforming. When a mutual fund outperforms a benchmark, the excess is known as “alpha” of the fund.
- Compare apples to apples
After comparing the performance of the fund with the benchmark, the next step can be to compare the performance with similar mutual funds. No mutual fund can be analysed in isolation. It is necessary to know whether the mutual fund can keep up with various trends in the sector, generate returns equal to (if not more) its competitors or outperform its competitors in various markets.
- Expense ratio
Investing in a mutual fund scheme without evaluating the expense ratio can take a chunk out of your profits. Expense ratio is the annual fees charged by the fund house to manage your portfolio. Actively managed funds usually have a higher expense ratio due to the cost of research, analysis and trading. Passively managed funds replicate the performance of the market index and tend to have a lower expense ratio.
Although expense ratio is an important aspect of analysing the performance of the fund, it should not dominate the process of fund selection. A mutual fund that has a higher expense ratio can be desirable too if it is able to generate higher returns.
- Fund History
By studying the fund history of the mutual fund, an investor can get key insights into the fund’s volatility, consistency as well as its ability to generate returns over various market cycles. The following aspects need to be considered while studying the past performance of the fund.
- Performance during different market conditions: When investing in a mutual fund, an investor prefers the scheme that can perform well in bear as well as bull market conditions.
- Managerial tenure: Stability in the management team or management with a longer tenure can give security to the investor.
- Fund’s objectives: A fund’s past performance must be in alignment with its objectives. A scheme that continuously deviates from its objectives can provide a feeling of insecurity to the investor.
- Maturity Period of Funds
Maturity period represents the average maturity period of the market securities within a mutual fund’s portfolio. The following points can help you understand how to analyse the mutual funds concerning their maturity date:
- It is important to determine the investment horizon while investing. If your investment horizon is short-term, a mutual fund consisting of securities with a shorter maturity period may be preferred and vice versa.
- Funds with a longer maturity period may provide a higher income potential as you lock in money for a longer time. However, it is crucial to evaluate the diversification and risk factors of the portfolio before locking in your funds.
The research appeared in the Financial Analysts Journal, “A New Framework for Analysing Market Share Dynamics among Fund Families”. The writer described how changes in market share is a metric to determine the strengths and weaknesses of a mutual funds firm. It identified four market performance components that measure market performance and if the company has outperformed or outsold its peers in the same category. It also measured the company’s gain from its exposure in the fund range and groups.
The market share of a mutual fund company is calculated based on AUM. Hence, change in market share also depends on the fund’s performance since inception. A fund gains market share when the total of its return and relative flow, measured by net flow as a percentage of AUM at the beginning of the fund, registers a higher value than the market.
The study breaks changes in market share in four components of business performance.
Category Performance Component
It is derived from the fund’s performance in the category against the market average.
Excess Performance Component
This is a factor to determine the performance against funds of the peer companies.
Category Flows Component
It measures fund flow against the market average in which the fund management company is active.
Excess Flows Component
Excess Flow Component evaluates a company’s performance in the same category against its peers in terms of higher relative flow.
Of the above four categories, Category Performance Component and Category Flows Component determine a company’s performance against the market, while Excess Performance Component and Excess Flows Component gauge comparative performance in the category. But, what do these metrics tell us?
| Category vs. Market | Fund vs. Category | |
| Performance | Category Performance Component
Determines whether the company is well represented in the category with favourable performance |
Excess Performance Component
Compares performance of the company against peers in the same category |
| Flows | Category Flows Component
Determines favourable net flow of the company in the categories it represents |
Excess Flows Component
Compares category peers in terms of sales |
Conclusion
Performance analysis helps mutual fund investors to select an asset management firm with stronger business performance. This article offers a comprehensive guide to assess the strength and potential of mutual fund schemes, ensuring that you choose the one that aligns with your financial goals.
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FAQs
How does benchmark comparison impact mutual fund performance?
Benchmark comparison helps assess a mutual fund’s performance relative to the market, indicating its effectiveness and potential for returns.
Why is the expense ratio important in mutual fund selection?
The expense ratio impacts net returns as it represents the cost of managing the fund. Lower ratios can lead to higher returns over time.
Why do we analyse mutual fund history?
Analysing a fund’s history provides insights into its consistency, volatility, and performance in various market conditions, aiding in assessing its reliability.
What is the Category Performance Component in a mutual fund?
It shows how well a mutual fund performs within its category compared to the market average, highlighting its competitive position.
How to check the mutual fund rating?
Ratings are available on investment analysis websites. These evaluate funds based on performance, risk management, and benchmarks.
Where can I check mutual fund performance?
Mutual fund performance can be reviewed on investment tracking websites, offering historical data and benchmark comparisons.
How do I know if my SIP is good?
Evaluate your SIP’s effectiveness by comparing its returns against the benchmark and similar funds over various time frames. Additionally, consider if the SIP has consistently met or exceeded its goals, and review its performance in different market conditions.
