So you have finally decided to invest in equity mutual funds to enhance your wealth. However, you have a challenge. There are 40 AMCs and over 1600 different types of MF schemes are on offer. Then there is uncertainty on the macro front and the micro front. How will you actually invest in mutual funds in the midst of all these uncertainties? Here is a 10-point primer on what to remember when investing in equity mutual funds:
1. Proof of the pudding lies in the eating. Don’t get obsessed with short-term returns, but do look at long-term returns. Ideally look at fund returns over a 3-year rolling period each quarter. That will help you to weed out the underperformers quite convincingly. That straight away rules out new funds that have just been launched.
2. Oh, that rules away new funds. What if they have merit? You are right. In the process you may miss out on the odd star performer that was launched last year. But 5-year pedigree and 3-year performance are the key.
3. When you evaluate funds, benchmark against the Total Returns Index (TRI). Your fund receives dividends from companies so the index must also measure the index returns including dividends.
4. It is better to invest in a fund with an AUM of Rs 2000 crore than a fund with an AUM of Rs 300 crore. The pressure of redemptions and sub-optimal decisions is lower in larger funds. Costs are also lower in the case of larger funds.
5. Focus on consistency of fund performance; it matters more than pure and absolute outperformance. What do we understand by consistency? Say, a fund that delivers returns of 15% per annum and the NAV moves from Rs 100 to Rs 152 in 3 years. Another fund delivers 18%, 28% and 0.75% returns in 3 years and the NAV at the end of 3 years is also at Rs 152. The first is obviously more consistent and, therefore, more predictable. When you buy equity funds you surely want predictability.
6. Focus on risk as much as on returns. What you effectively want is risk-adjusted returns. Rather a prudent fund manager than one who shoots from his hip. If Fund A earns 18% returns with 20% standard deviation (risk), then it is a good performance. There is another Fund B which has given 22% returns but that has come with a standard deviation of 50%. You don’t want a fund manager generating returns by taking on higher risk. That is punting and you can also do that. Fund A is a better choice for you.
7. Have the key personnel stayed with the fund for a long time? You may wonder why this is relevant. When key people like CEO, CIO and fund managers keep changing, there is no consistency of policy and strategy. When fund teams stick around longer, they build rapport and that helps them in enhancing performance. Most investors get comfortable with a fund management team and do not want it changing constantly. In fact, one of the reasons why people exit certain funds is the change in the management. It does matter a lot to performance and to strategy.
8. Always adopt a Systematic Approach to investing in equity mutual funds. What do we understand by an SIP? Instead of trying to invest in lump-sum you invest regularly. Say, an SIP of Rs 10,000 per month for 25 years can generate a huge corpus for you. The benefit of SIP is that it gives you the benefit of rupee cost averaging which reduces your cost of acquisition of the fund and enhances your ROI. It also syncs better with your regular income flows and you can directly tag SIPs to your long-term goals.
9. Last, but not the least, never invest in equity funds at random. Start with your long-term and medium-term financial plan and work backwards. Create equity fund SIPs for long-term goals and debt fund SIPs for short to medium-term goals. Be conservative in your return estimation when you are looking at long-term goals.
10. Do not panic and sell out when there are short-term corrections in the market. In the short term of less than 3 years, the equity markets might be volatile, but you will see good returns if you stay invested for a medium to long-term horizon.
Remember, once your home work is done, the rest of the pieces automatically fall together in the selection of an equity fund.