16.10 Picking the right mutual fund

Greatest ever return by any company in last one year !!!" - Perhaps you must have noticed many such mutual funds ads in the past. At times, the focus on past performance is so overwhelming that it leaves investors with the impression that the past is all that matters while investing in a mutual fund (please note that when you compare past performance, consistency is another benchmark). Certainly past performance is important, but among other factors that rarely find a mention in advertisements are the fund house's investment philosophy and processes, level of ethics, performance across market phases especially the downturns.

It is important while analyzing mutual funds that we can consider a fund's performance against its peer group as well as against its index. If other similar funds with similar mandate have given us comparatively lesser returns, then of course it is interesting to look at that fund. Moreover, please remember to compare similar schemes of different companies, rather than different schemes. (For example, don’t compare XYZ company's growth fund with ABC company's dividend fund). Other than returns, you should also consider the risk taken by the fund manager because different funds will have different levels of risks attached to them. Before picking a fund, you should know the asset class you want to add to your portfolio. Are you looking for a large-cap growth fund, for example, or a small-cap value fund? Therefore, have a closer look at the fund allocation table.

Also, it is worth looking at the loads of the fund. See what they charge as front-end or back-end fees called loads. With so many excellent no-load funds, there is simply no good reason to pay a sales charge. Tools like Sharpe ratio (where the daily returns of the index are deducted from the daily returns of the equity scheme. The average of this series of daily differential returns is divided by the standard deviation to arrive at the Sharpe ratio.), Treynor's index also give us some indication about the performance of mutual funds. Long-term investors should focus on long-term results, keeping in mind that even the best performing funds have bad years from time to time.