Mutual Funds: Factors to Select the Category

An investor needs to select the mutual fund category on the basis of investment objective, time horizon and risk tolerance. After this, one has to choose a mutual fund scheme within that particular category. Here’s a list of factors on the basis of which this needs to be undertaken:

Performance against benchmark or index: A benchmark index of a mutual fund scheme is a standard against which its performance and stock allocation are compared. The asset allocation of a benchmark index must match the investment objective of the mutual fund scheme. For example, the benchmark index of a large-cap mutual fund must be an index of large-cap stocks and the benchmark of a mutual fund focussed on banking stocks should be a banking index.

As per the markets regulator Securities and Exchange Board of India (SEBI) mandate, mutual funds need to consider the total returns index (TRI) variant of indices as their benchmarks. TRIs relate to the assumption that dividends are reinvested in mutual funds as and when they are declared. 

Performance against category: The performance of a mutual fund scheme in comparison to its active peer group is needed to be considered. This comparison needs to be only among the same type of mutual fund schemes. For example, a large-cap equity mutual fund would be compared only with other large-cap mutual funds.

Consistency of performance: A mutual fund scheme offering consistent good returns over a period is ideal for investors. This includes consistent returns during both phases of the stock market – bull or bear runs.

Fund manager’s experience: Take into account a fund manager’s experience with the mutual fund scheme in question in accordance with other funds that are currently being managed or managed in the past by them.

Asset Management Company’s (AMC’s ) track record: An AMC or fund house is responsible for managing a mutual fund scheme.  It remains crucial to check the track record of an AMC before zeroing in on a mutual fund scheme. 

Assets Under Management (AUM) of the scheme:  Simply put, AUM relates to the number of subscriptions the scheme has received. In the equity category, especially in small-cap funds, a large AUM can pose a difficulty for the fund to enter and exit companies. While larger sizes of AUM are favourable in the case of liquid and short-term debt funds considering it makes the fund less vulnerable to redemptions made by large investors.

Expense ratio: The expense ratio relates to the fee charged by an AMC for the administration, management, promotion and distribution of a mutual fund. Every expense incurred in the running of the fund is included in an expense ratio. SEBI has capped the expense ratio at 2.25% of the total fund assets.