How to compare Equity Mutual Funds?

When comparing Equity Mutual Funds, a variety of parameters are popular and considered. The most widely used ones are listed below.

1. Compare Mutual Fund Performance with a benchmark:  

You can begin by comparing a fund’s performance to the benchmark. Use a fair and acceptable benchmark for comparing. Always make an apples-to-apples comparison. Using the incorrect measurement will result in inaccurate statistics.  

Take, for example, a Large-Cap Equity Fund. When compared to a broad and diverse index like the Nifty 50, it performs better. 

2. History of the Funds: 

The market value of a mutual fund can only be determined during market corrections, as evidenced by fund history. Look for a fund with a longer track record, such as 5 to 10 years. Compare the performance of a fund throughout different timeframes and business cycles. 

Assume that a fund has consistently generated returns that are in line with expectations during a market rally. Furthermore, if the fund lost 8% of its value during a downturn and the benchmark dropped 10%, it is considered that the fund did well. 

3. Fund Expense Ratio Comparison: 

The annual cost imposed by the fund for managing your investment is known as the expense ratio. According to SEBI regulation, fund houses are not allowed to charge more than 2.5 percent of the fund’s average Asset Under Management (AUM). Before investing in a mutual fund, make sure to look at the fee ratio. 

The expense ratios are deducted from the fund’s returns. As a result, the larger the expense ratio, the smaller your take-home revenue. Always seek a fund with comparable results but a lower expense ratio. 

A direct plan and a regular plan are both available for the same mutual fund. Mutual fund direct plans have a reduced expense ratio, which correlates to higher returns. Investing in mutual fund direct plans rather than ordinary plans can save you a lot of money in commissions. 

If the returns provided by your premium fund do not match the fee charged, you may want to consider passive investing. Look for index funds that meet your budget because they are less expensive and give returns that are comparable to the underlying benchmark. 

4. Track Fund Managers historical performance: 

A large number of equity fund investors have no understanding of what their fund manager’s strategy is. They have no idea the stocks he has been buying and selling month after month. Investors haven’t been able to keep track of their fund manager because they lack a portfolio history that allows them to determine whether the fund management is following a strategy or simply timing the market. There is also a category of investors that do not use fund management and instead invest on their own. They do, however, like to observe what popular fund managers are buying and selling to feel confident in their investments. 

Fund management is a complicated procedure that involves a great deal of financial expertise and investigation. This is why, when choosing a mutual fund, you should choose with a reputable and experienced fund manager. When evaluating a fund manager, consider the following factors: 

• Industry experience. 
• Manager rankings by leading institutions. 
• The funds they are actively managing have a track record in the past. 

5. Examine the risk-adjusted returns: 

Look for risk-adjusted returns of the fund rather than just annualized returns. A higher level of risk should be balanced by a higher level of return, according to the risk-return tradeoffs. The risk is calculated using the standard deviation. 

The Sharpe ratio can be used to determine whether a fund is providing better returns for each additional unit of risk taken. The fund manager achieved higher returns for the extra risk taken since the Sharpe ratio was higher than the category average. 

Consider the two equity funds A and B, each with a standard deviation of 13% and 17%, respectively. If the Sharpe Ratios of funds A and B are 0.47 and 0.60, respectively, choose fund B since it is a better bet for the risk. If B’s Sharpe Ratio was near 0.50, though, you may have gone with A. It’s because a 0.03 extra return isn’t worth taking on an extra 4% risk for a 0.03 extra return. 

The Sharpe Ratio can be used to evaluate the performance of different equity mutual funds to a benchmark index. It aids in determining the risk-adjusted return of equity funds. The Sharpe Ratio is a technique that may be used to compare the performance of a mutual fund or a portfolio. It compares the standard deviation of the portfolio return to the excess portfolio return over the risk-free rate. 

Let’s look at an example of the Sharpe Ratio. You’re comparing Fund A and Fund B, two separate equity funds, to see which has the superior risk-adjusted return. 

Sharpe Ratio = (Portfolio return – Risk-free rate of return) / Standard deviation of the portfolio. 

Sharpe Ratio (Fund A) = 13% – 5% / 6 = 1.33  

 Sharpe Ratio (Fund B) = 11% – 5% / 4 = 1.50 

Fund A has a higher expected return as compared to Fund B. The volatility, on the other hand, is higher. When compared to Fund A, Fund Y has a greater Sharpe Ratio and a higher risk-adjusted return. 

6. Compare the Alpha and Beta of various mutual funds: 

The number of extra returns achieved by the fund over the benchmark returns is measured by alpha. The riskiness of a fund is measured by its beta. It also displays if the fund loses or gains more or less than the benchmark. If the beta value is greater than one, it means the fund outperforms the benchmark. 

A beta of one means that the mutual fund’s returns move in lockstep with the benchmark. The fund will gain or lose less than the benchmark if the beta is less than one. Consider two funds A and B with the same beta level, i.e., if the alphas of funds A and B are 2 and 1.75, respectively, you should go with fund A. It’s because the fund manager can deliver greater returns than the benchmark for the same amount of risk. 

7. Evaluate the Portfolio Turnover Ratio (PTR): 

The portfolio turnover ratio indicates how frequently the fund manager purchases and sells securities in the portfolio. In the case of equities funds, it indicates the amount of trading that takes place within the fund. You should be aware that when you buy or sell an equity share, you will incur transaction fees such as brokerage. 

Frequent trading in a portfolio results in increased expenses, which is reflected in a higher expense ratio. It could lower your fund’s take-home earnings. As a result, PTR is an essential consideration for selecting funds. 

When selecting a fund, choose one with a lower PTR. If you want to invest in a fund with a high PTR, be sure that the high PTR is justified by higher returns. 

8. What MyGoalMySip can do for you: 

It can be extremely challenging to choose a mutual fund mentioned in previous parameters unless you are an active investor who closely monitors market movements and related indicators. Based on your financial goals, MyGoalMySip can assist you by handpicking the most suited and best-performing investment portfolios for you. 

Read Next: How to become a crorepati?

For more information, reach us at [email protected]

Team, MyGoalMySip.