When you invest in any mutual fund scheme, the first thing you may have done most likely is look at recent returns and invested in funds with the highest returns.
As much as this seems like a great way to begin, it can
actually be very misleading.
Past mutual fund returns like statistics often reveal what
could have been concealed and hides what should have been concealed.
This is why you should not invest based on internet search
results of:
- Best performing mutual funds
- Best sip plans
- Top performing mutual funds
So how do you study mutual funds performance?
 |
SEBI
Recategorization
Mutual funds in India are regulated by the Securities and
Exchange Board of India (SEBI).
The regulator SEBI in 2018 decided to undertake
recategorization exercise of mutual funds according to which mutual fund
schemes would have to invest according to certain set rules.
These include but not limited to:
- A Large cap fund needing a mandatory 80% allocation into large cap stocks.
- A Mid cap fund needing a mandatory 65% allocation into mid cap stocks.
- A small cap fund needing a mandatory 65% allocation into small cap stocks.
- A Large & mid cap fund needing a mandatory 35% allocation each into large cap and mid cap stocks and so on.
What these new rules meant was now mutual fund schemes had
to either rejig their portfolio or move them to a completely new category.
Additional reading: Click Here to read our complete review of Kotak Standard Multicap Fund
These new rules therefore made past performance/returns of
mutual funds redundant.
- Invesco Growth Opportunities Fund, currently a large and mid-cap fund was previously a large cap fund.
- Kotak Standard Multicap Fund, currently a multicap fund was previously a focused fund.
- Parag Parikh Long Term Equity fund, currently a multicap fund was previously a value fund.
Imagine if you had invested in these mutual funds based
purely on their past returns without considering the change in their:
- Category
- Investing style
- Portfolio strategy
- Sector allocation
- Stability
- Your future goals
- Your risk profile
Fundamental
changes to Fund scheme
Any mutual fund scheme at any time could undergo changes that
could change it completely from what it is was in the beginning.
Case in point:
When Mirae Asset Multcap fund changed its category from
multicap to a large cap fund.
This completely changed the fundamental characteristics of
the fund, as a multicap fund it could invest across all caps with no
restrictions but as a large cap fund it needed a mandatory 80% allocation into
large cap stocks.
You therefore cannot expect a large cap and multicap fund to
perform similarly even though they belong to the same fund house.
Another example could be when SBI small cap fund stopped
accepting fresh lumpsum investments into its fund and allowed investments via
SIP and STP.
How a fund receives money and the flow also matters, more so
the case with mid and small cap funds.
- Expecting the fund to behave similarly in both cases be it with returns or volatility would not be fair.
- In both the examples with changes to the funds, you cannot compare past returns with current returns and should not expect future returns to be in line with past returns.
- Although this should be the case for any equity mutual fund,
it is so more the case when the fund has undergone significant changes thereby
completely changing how it is run.
Fund
Manager
Let’s say you have done no research on the fund manager and just
looked online for general terms like ‘top performing mutual funds’ and ‘best
sip plans’.
The funds that come up in search engines would usually be
the ones with the highest returns in recent times.
What you would not be aware though is the cause for these so
called high recent returns.
Sometimes a particular mutual fund may have done well
recently due to its bet on a certain or a couple of sectors coming off well.
Principal Focused Fund in 2019 allocated a higher allocation towards the Chemical sector, the fruits of which it bore in 2020.
Not all sectors do well simultaneously and not all bets pay
off the way we want them to.
In a similar manner a reputed fund manager and fund house has recently come under harsh criticism for its over exposure to Public Sector Unit companies.
There’s no way to confirm that this strategy will not work
in the future too because times change, economies undergo transformations and
mutual fund schemes also go through various ups and downs.
Knowing why your mutual fund is doing well is as important
as knowing why your mutual fund is not doing well.
Additional reading: Click Here to read our complete report of why you should NOT invest in Dividend mutual funds.
Fund
Strategy
Two mutual funds of the same category with the same
restrictions and possibilities can still be run very differently and thereby produce
returns that could be miles apart.
With such mutual funds you would need to have a better
understanding of how they function and whether or not they are aligned with
your risk profile.
Invesco multicap fund has a higher allocation to mid and small cap stocks and thereby usually outperforms its peers when mid and small cap stocks rally and underperforms comparatively when mid and small cap stocks are volatile.
Assuming mid and small cap stocks are rallying thereby
pushing up the returns of Invesco multicap fund too, the thing with mid and
small cap stocks though is that they tend to be very volatile in the short run.
Now if you enter the fund based purely on recent high
returns when mid and small cap stocks were rallying, you would be extremely
disappointed when these mid and small cap stocks also underperform if the
market is going through a volatile phase.
- You would assume your pick of fund is wrong, shift to another fund and thereby end up only resuming your mistake.
- This is because other multicap funds with lower exposure to mid and small cap stocks would have performed better due to lower volatility.
You need to understand your reasoning behind your choice of
fund before investing, when staying invested and also when you decide to
redeem.
Another case study for better understanding here could be
Parag Parikh Long Term Equity fund.
The fund has outperformed its peers for the period between
April 2020 to September 2020.
A period of 6 months for an equity mutual fund life is
extremely short to make any meaningful conclusion out of it.
Anyway, what contributed to the funds outperformance during
these 6 months could be attributed to the following points:
- Higher cash bets
- Exposure to US companies
- Minimal exposure to mid and small cap stocks.
Parag parikh long term equity has historically taken higher
cash calls which helps it during a bearish market phase but works against it
during a bullish market phase.
The fund’s international exposure was limited to US stocks
except for one and all these US stocks were confined to the technology space.
The US stock market is more technology driven whereas its economy is more consumer driven.
The fact that IT companies could afford to have their
employees work from home with little to no disruption to their work was nothing
short of a privilege considering the times.
There’s no way Parag Parikh Long Term Equity fund could have
predicted the entire world going through such difficult times, let alone global
economies.
Now you cannot enter the fund expecting same, similar or
linear returns too because times were different back then, are different now
and will continue to be different in the future.
May be the fund could cut down its exposure to US and US
based IT companies in the future or may be these companies could be left behind
by other sectors or companies within the same space.
The performance of Parag parikh long term equity fund would
have been different in the past as compared to the 6 month period and therefore
it becomes all the more important to understand the functioning of any equity
mutual fund.
Goals and needs should take precedence over returns and
wants when making a mutual fund portfolio but unfortunately the opposite of
that is true, more so with first time and inexperienced investors.
We are living during times when there is so much noise with
business news channels, newspapers and apps and yet little to no knowledge as
to how to go about building and maintaining one’s mutual fund portfolio.
We have too much unnecessary information and yet very little
credible knowledge.
When you keep on chasing recent returns you end up buying
and selling, that is trading and not investing.
This has implications on:
- Your taxes
- Your portfolio
- Exit load charges
Sooner or later you would get the feeling that mutual funds are
not the right source of investment for you, when in fact you never were able to
utilise the resources in hand very efficiently.
For portfolio enquiries, email us with your doubts at info@themutualfundguide.com
