How To Select Winning Mutual Funds?
The ‘Mutual Funds Sahi Hai’ campaign has really taken off since 2017. But the question which I get asked often is ‘Konsa Mutual Fund Sahi Hai?’ (Which Mutual Fund is a good investment?).
I think this is a question which many of you have, but I don’t feel it is necessary to be always invested in the best mutual there is to create substantial wealth from the stock markets. To understand what I mean by this, sit back and read below.
What is a Mutual Fund?
To those of you who don’t know what exactly a mutual fund does, let me first explain it. If you are already familiar with what mutual funds are, you can skip this part.
In short, a mutual fund is an asset class that pools in money from a large number of people which is invested ‘mutually’ in various investment vehicles, like stocks, bonds, treasuries etc.
Fund Manager – This is probably the most important aspect of investing in a pool. When multiple investors collect their money, someone needs to manage it meticulously. The Fund Manager is responsible to invest the collated money on the behalf of investors into various investment instruments. This is a huge responsibility since he/she is managing hard earned money of the investors. The track record of the Fund Manager is extremely important while picking a Fund.
Assets Under Management (AUM) – The total market value of the collective funds invested. If you look at any mutual fund, you can find the AUM Value. The higher the AUM, the more stable the fund is.
Portfolio – The combined underlying holding of the Fund is known as Portfolio.
NAV (Net Asset Value) – This can be considered analogous to share price. NAV is a Mutual Fund’s price per share or Exchange Traded Fund’s (ETF) per-share value. In both cases, the per-share rupee amount of the fund is calculated by dividing the total value of all the securities in its portfolio, less any liabilities, by the number of fund shares outstanding.
Units – The part of the portfolio which the investor owns in the Fund. Generally, based on the NAV, we can buy the number of units which we can afford based on our investment plan. You can consider this as similar to the number of shares in one’s portfolio. The only difference is that we can buy partial units, which is not possible in case of shares.
Expense Ratio – This is the fee which is paid by you to the fund house for managing your money.
Exit Load – Some mutual funds have an exit load, which means that if you redeem your money before the specified time period, you will be charged some amount.
There are various types of mutual funds, like equity, debt, hybrid, etc. If you want to know about these in detail, you can refer to Zerodha Varsity’s module on mutual funds. It has explained all the types in a simplified manner.
Which is the best Mutual Fund?
Now let’s come back to our million dollar question. Let us look at some data which I have taken from Moneycontrol as at the end of November 2020. Also, SIP returns are considered here, because for most of the people reading this, SIP would be the best way to build wealth over the longer term.
P.S.: SIP means Systematic Investment Plan, which is same as “Dollar Cost Averaging”.
I have listed the top 10 Large Cap Mutual Funds according to their SIP returns for 1 year, 2 years, 3 years and 5 years.
NOTE: THESE FUNDS ARE NOT RECOMMENDATIONS FROM MY SIDE. PLEASE DO YOUR OWN RESEARCH BEFORE BUYING ANY MUTUAL FUND.
If we arrange all these in a single table, we will get something like this.
If you carefully observe this image, you will notice something interesting.
- SBI Bluechip Fund is ranked first in 1 year returns, but is ranked 5th in 2 year returns, 10th in 3 year returns, and is not even in the top 10 when it comes to the 5 year returns.
- Mirae Asset Large Cap Fund is 3rd in 5 year returns, but is 9th in 3 year returns, not in the top 10 in 2 year returns, and is 8th in 1 year returns.
The position of any particular fund fluctuates widely when it comes to its performance during various timespans.
Comparing funds just like this in other categories like Small Cap, Mid Cap, Multi Cap etc. will also throw similar results.
What do these fluctuations tell us?
We simply get to know that the best mutual fund in one particular year might not be the best one over a period of two years, or three years, or even five years. Sometimes, your mutual fund might do worse, the other times it might be the best in its category — it shouldn’t matter to you whether or not you are invested in the best mutual fund at all times.
If you have researched about the mutual fund well enough, your fund will do well enough over time, provided you stay invested through the ups and downs of the market. You also not be caring whether or not you outperform or underperform the index. Your goal is to build a corpus that takes care of your goals, not to beat the index. A corpus is built over a period of time by taking help of the power of compounding. Morgan Housel has said it perfectly:
“The math of compounding means the biggest wins don’t necessarily go to those with the highest returns; they go to those who earn pretty good returns maintained for the longest period of time.”
If we just add one more fund to these funds, we will get some great insights. Let’s see what returns did the largest index fund gave in the same period of time.
As we can see, the UTI Index Fund was in the top 10 for all the four time horizons, barring one. This tells us that simple index investing wouldn’t make any significant difference to the returns, and will save you the trouble of selecting “best mutual fund”.
Selecting a good mutual fund
There are over 2,500 different mutual fund schemes available in India. If we want to select good mutual funds, we need to avoid the bad ones. These are the schemes which we must avoid (I am talking only about the equity schemes):
- Sectoral funds: Sectors always change when it comes to the stock market. Investing in any particular sector would mean staying invested in it, whether or not it is in favor. For example, IT fund, Pharma fund etc.
- Thematic funds: Same as sectoral funds. For example, Dividend Yield Funds, ESG Fund etc.
- NFOs: These are similar to IPOs. You don’t have any track record of these funds.
- FoFs: These are funds that hold other funds. Why do you want to pay double expense ratio?
After you have avoided these, you will now be left with Large Cap, Mid Cap, Small Cap, Multi Cap, Index Funds, ELSS (Equity Linked Savings Scheme), Value / Focused Funds. Select your funds from these categories. Now, there are some things which you must look at within each fund:
- Look for funds that have a good track record over 10+ years.
- Check the fund manager’s track record.
- Look at portfolio turnover. You want this to be low.
- Ignore the “star ratings”.
- Look for low expense ratio. Though this should not be given much of a priority.
If you follow these rules, you will end up owning some good mutual funds, and shouldn’t matter whether they underperform for some time, what matters is how long you would stick with them and let your compounding engine run.