Track how your mutual fund investment is faring

The time lag between the date of investment and goal accomplishment can be frustrating for any investor. This time horizon can vary from a few months to as long as 20 years, during which a lot of changes in terms of inflation and market might have occurred. This is why you should always track your investment performance and continue to make adjustments and allocations accordingly.

You must track your mutual fund performance at least once or twice a year, which will help you weed out consistently poor funds. Here is a list of tools and metrics to check how your mutual fund investment is faring.

1. Fund Returns

You can assess how your fund has performed by using fund returns. You may compare the returns generated by your fund with returns produced by other funds. Also, you need to compare the fund returns with the underlying index (like Sensex, Nifty).

If your fund returns are higher than the index returns, then it shows outperformance of your fund. It is a sign of superior performance. On the other hand, if fund returns are less than index returns, it indicates an underperforming fund.

If your fund has underperformed consistently for 3-4 quarters, then it’s better to move on to another.

An SIP investor should use trailing fund returns for comparison purposes. Annualised returns give accurate results only when you are investing via a lump sum.

2. Fund Alpha

Alpha is the difference between returns generated by your fund and that by the underlying index (like Sensex, Nifty). It is used to analyse whether the fund manager’s strategy resulted in superior fund performance or is it just luck.  

Especially in a rising market, almost all the schemes may experience a rise in fund values. At this juncture, alpha helps to reveal how much of the fund returns can be attributed to the fund manager’s investment strategy.

If your fund’s alpha is higher than other competitive funds, then it shows effective fund management. A consistently low alpha shows poor fund management. It may be better to switch than continue.

3. Risk-adjusted Returns

You should be compensated according to the investment risk assumed. Higher risks call for higher returns. Sharpe Ratio of a fund is a financial ratio which helps to know this. It shows how much extra gains has your fund produced in return for taking higher risk. A higher ratio indicates higher returns for every extra unit of risk taken.

Sharpe Ratio of each fund is available in the factsheet of the fund. You may take it from there and compare it with that of other funds’ Sharpe Ratio. A fund giving lower risk-adjusted returns across time horizons explains the need to exit.

4. Portfolio Turnover Ratio (PTR)

PTR reveals the frequency of trading activity within a fund. A high PTR implies frequent adjustments being made by the fund manager. He/she may buy well-performing stocks and sell poor-performing stocks. It is a way to benefit from the market movements.

Also Read: Does the size of the mutual fund affect fund selection

Low risk-adjusted returns in the face of high PTR shows bad fund management. It calls for a relook at the particular mutual fund. Consistent poor performance indicates a need to move to better funds.

5. Investment Style

A fund should invest in securities according to its investment objective. If the fund manager’s investment style conflicts with your risk tolerance, then it’s time to explore other options.

Consider a multi-cap equity fund which was inclined to large-cap stocks initially. Over a period of time, the fund has increased allocations to mid-cap stocks. On one hand, it has raised the fund’s return potential of the fund. On the other hand, it has made the fund riskier. Such fundamental shifts beyond your comfort zone call for a switch.

Do’s and Don’ts during performance measurement

Always compare funds which fall in the same category. Don’t compare a large-cap fund with a small-cap fund. As the latter is a riskier proposition, it will always have a higher return potential.

Don’t measure the performance of small-cap against a broad-based index like Nifty. Ensure that market capitalisation of the fund and the benchmark are the same.

Don’t refer short-term fund performance for long-term goals. Match your investment horizon with the performance period under consideration.

Make portfolio changes only after careful consideration as they can be costly and increase the fund’s expense ratio. It is better to compare the fund’s Sharpe ratio with PTR to get the complete picture.

The Bottomline

All the ratios listed above may become basic parameters to judge your fund’s performance. While doing this, however, keep the broader context of your financial goals in mind.