How to decode mutual fund returns
* Know what to look for and what to discount while assessing the past performance of a mutual fund
* In the absence of rolling return data, look at calendar year performances and trailing returns
Mutual Funds
The return from a mutual fund is typically the start point of evaluating the performance of any mutual fund. While past performance cannot be a guarantee for continued performance in the future, knowing what to look for and what to avoid while assessing past performance can go a long way in making better investment decisions. Make sure the returns show you the whole picture before you make an investment choice.
Define the category
As a first step, you may list funds with the highest returns in the asset class you choose, but this list may not suit your core portfolio needs. For example, the funds that generated the highest one-year return as of 8 November were banking and financial services funds in the equity asset class, and gilt funds in the debt asset class—both tactical fund categories. If you invested in these, you may end up with funds that perform well only in a particular economic cycle or situation.
You should consider the returns only after you have identified the category of funds that meets your investment objectives. “Investors suffer from recency bias and would be tempted to select the funds with the best recent returns," said Srikanth Meenakshi, co-founder, PrimeInvestor.in, a personal finance research platform.
“But this may lead to undesirable choices. It is important to compare the performances of funds of similar profile," he added. For example, if you are willing to take some risk for a goal that is 10 years away, then the multi-cap category may suit your needs, and you may consider the returns of funds from this category.
Using trailing returns
Trailing returns, say the return from a fund over the last five years, is sensitive to the level of the fund value at the start and end points of the period. If the markets and, therefore, fund values were low at the start point and high at the end date then the returns will look very good and vice-versa. A small shift in the dates considered for calculating the returns may change the complexion of the fund’s returns.
For example, the performance of large-cap funds in the period before the general election results in May 2019 and post that event will show significant difference with the funds coming to their own as large-cap indices rallied. The investment strategy adopted by the fund, such as value investing or focused portfolios, may also explain the outperformance of some funds in a particular period. But this may not sustain across market cycles.
Use trailing returns over longer investment horizons, seven years and more, where performance history is available, that would have captured different market conditions to get a better idea of a fund’s performance. “Indian equity investors have only seen a bull market since 2013 and they need to go beyond that period to see how a fund has performed in different market scenarios, including bear markets," said Amit Kukreja, a registered investment adviser and founder, amitkukreja.com. “In case of debt funds, the evaluation period can be much shorter since the debt markets have seen credit cycles and interest rate cycles in the last five years," he added.
* In the absence of rolling return data, look at calendar year performances and trailing returns
Mutual Funds
The return from a mutual fund is typically the start point of evaluating the performance of any mutual fund. While past performance cannot be a guarantee for continued performance in the future, knowing what to look for and what to avoid while assessing past performance can go a long way in making better investment decisions. Make sure the returns show you the whole picture before you make an investment choice.
Define the category
As a first step, you may list funds with the highest returns in the asset class you choose, but this list may not suit your core portfolio needs. For example, the funds that generated the highest one-year return as of 8 November were banking and financial services funds in the equity asset class, and gilt funds in the debt asset class—both tactical fund categories. If you invested in these, you may end up with funds that perform well only in a particular economic cycle or situation.
You should consider the returns only after you have identified the category of funds that meets your investment objectives. “Investors suffer from recency bias and would be tempted to select the funds with the best recent returns," said Srikanth Meenakshi, co-founder, PrimeInvestor.in, a personal finance research platform.
“But this may lead to undesirable choices. It is important to compare the performances of funds of similar profile," he added. For example, if you are willing to take some risk for a goal that is 10 years away, then the multi-cap category may suit your needs, and you may consider the returns of funds from this category.
Using trailing returns
Trailing returns, say the return from a fund over the last five years, is sensitive to the level of the fund value at the start and end points of the period. If the markets and, therefore, fund values were low at the start point and high at the end date then the returns will look very good and vice-versa. A small shift in the dates considered for calculating the returns may change the complexion of the fund’s returns.
For example, the performance of large-cap funds in the period before the general election results in May 2019 and post that event will show significant difference with the funds coming to their own as large-cap indices rallied. The investment strategy adopted by the fund, such as value investing or focused portfolios, may also explain the outperformance of some funds in a particular period. But this may not sustain across market cycles.
Use trailing returns over longer investment horizons, seven years and more, where performance history is available, that would have captured different market conditions to get a better idea of a fund’s performance. “Indian equity investors have only seen a bull market since 2013 and they need to go beyond that period to see how a fund has performed in different market scenarios, including bear markets," said Amit Kukreja, a registered investment adviser and founder, amitkukreja.com. “In case of debt funds, the evaluation period can be much shorter since the debt markets have seen credit cycles and interest rate cycles in the last five years," he added.
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