Evaluating a mutual fund

For an individual investor, sometimes it is difficult to judge which mutual fund is good and which one is
not. The parameters for evaluation differ depending on the fund type. There are different parameters for
an equity fund and different ones for a debt fund.

In case of equity funds:

• Performance:

In case of an equity fund, you can begin by looking at its performance as measured in absolute
returns from the fund. The Securities and Exchange Board of India (SEBI) has standardised
returns declarations on the fact sheet. A declaration is on a compounded annualised basis for a
period of more than a year and on absolute basis for less than a year.
 • Returns against benchmark

You should look at an equity fund's returns for various periods vis-a-vis its benchmarks. The
benchmarks may be varied - the interest rates, Sensex level, or some other index. The
performance should be seen over a long term - say two to three years. You should compare the
latest NAV with the unit value during the time of purchase. Absolute returns are the first
yardsticks an investor should look at.
• Portfolio of fund

You should also examine the portfolio of the fund to gauge its quality of investments .
Ultimately, it is the portfolio that will yield the returns. A portfolio should be in line with the
mandate of the fund. For example, a pharma fund should have pharma stocks and a gilt fund
should have investments in gilt securities. In case of a diversified equity fund, you should check
whether the fund is adequately diversified across sectors and companies rather than limiting its
investment sphere to a narrow gauge. Funds are supposed to give sector-wise break-up along
with details of company holdings.

• Portfolio turnover ratio

Another tool to evaluate a fund is the portfolio turnover ratio. This gives an understanding of the
extent of portfolio movements . A ratio of 100 percent indicates that the fund changes its
complete portfolio each year. A ratio of 50 percent indicates that the fund changes its complete
portfolio every two years. Frequent churning increases the risk profile of the fund. Also, it means
the fund is incurring additional transaction costs.
Debt fund:

In case of a debt fund:

In case of a debt fund, apart from the two parameters of absolute returns and portfolio turnover
ratios, you should also look at the ratings break-up for the fund's corporate bond holdings . This
indicates the quality of the portfolio. Investing in company bonds has an element of risk. You
should check the ratings of the bonds in which the fund has invested. The credit rating gives a
good indication of the security profile of the fund.

Portfolio maturity
In addition, you should also look at the portfolio maturity. This is the average tenure of the bond
portfolio of the debt fund. It indicates the susceptibility of the fund to changes in interest rates.
Bond prices and interest rates move in opposite directions.

As such, any rise in interest rates may lead to a fall in bond prices and hence the NAV of the debt
funds, and vice versa. If the fund expects interest rates to fall, it might increase the maturity of the
debt portfolio to gain from a probable rise in bond prices. Increasing maturity to very high levels
might be construed as too high for a debt fund, because in case the interest rates rise instead of
falling, the losses would also be relatively more.

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