7 Things To Look For, Before Investing In Mutual Funds

Mutual Funds are investment avenues in which investors deposit money that get invested in shares, or debt instruments. These are run by professionals to generate superior returns for investors.

Investors leverage skills of fund managers to earn returns on investment. Mutual funds are categorized into Equity, Debt, Hybrid or theme based. SEBI has further subcategorized each of these based on the size of asset being managed, tenure, purpose, etc.

The categorization of funds helps investors to narrow down options to suit their specific requirement.

Equity Mutual Funds are closely related to the stock market performance. Fund managers study the market carefully to get the right combination of equities, debt instruments etc., to be ahead of the index consistently. Generally speaking rising index suits equity funds while falling index favor debt instruments.

The choice of mutual funds depends on a variety of factors. The most important being the objective of the investment. The time horizon, available corpus and one's propensity for risk are also factors. It is not desirable to choose a fund simply because it has a solid track record.

While choosing Mutual funds identify the category based on your objectives and then compare available option on their merits. Some of the more important criteria are as follows:

1) Rating

Ratings enable you to narrow down the options available. Mutual fund ratings are provided by Crisil as well as Value Research online. Ratings should be checked from a variety of other sources as well and then studied over time. Consistency is key to predicting the likely future fund performance.

Both, Crisil and Value Research Online have a proven track record with their ratings. However, mutual fund investment is subject to market risk.

2) Performance

This is indicated by returns in percentage terms. Remember past performance need not correlate linearly with what happens in the future but is indicative. Consistency is preferred and volatility undesirable. A drop in returns consistently over two or more quarters suggest weakness.

Performance should be checked over one, three and five years to be conclusive.

3) Assets under management

A schemes popularity is also gauged by assets under management. Several schemes like ICICI Prudential Value Discovery and HDFC Equity have assets in excess of Rs 20,000 crores under management.

So, if investors want to go by large-sized equity funds, they can opt for these. Assets under management is a measure of the popularity of the fund. Short fall in assets under management is a significant risk as it limits the flexibility of fund managers. But comparison should be made within the category.

4) Broad Bench Marking

Mutual funds which are bench marked against a broader base, like CNX 500 are preferable to narrower bench marks like Sensex. Broad bench marks afford the fund manager the opportunity to cash in on the performance of Mid-caps, Small-caps, etc.

5) Expense ratio

Expense ratio is the amount of money that the asset management company would charge to the scheme, due to expenses like marketing costs, advertising, brokerage charges. Higher the expense ratio, lower would be the returns for investors. For example, SBI Bluechip Fund from the SBI stable has an expense ratio of only 1.97 per cent, compared to 2.2 and 2.3 per cent of other equity mutual fund schemes.

The expense ratio reduces the returns but are inevitable to mutual funds. Less than 2% is good, but beyond that one needs to be wary.

6) Reputation of the Fund House and Fund Manager

Both warrant close examination and seek expert advise. The former merits greater attention than the latter. Star managers may not be around too long to manage your funds. Good fund houses build teams that follow sound principals and healthy consistent practices. It also shows on their performance.

7) Exit load

Exit load is charged for withdrawing from the scheme, before a certain time period. Ideally it is one per cent, if you withdraw money before one year. Watch for the exit load carefully before investing.