evaluating equity fund performance

A step-by-step guide to evaluating equity fund performance

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Investing in equity mutual funds can be a rewarding experience, but choosing a fund that will outperform over the long run is not easy. There are hundreds of funds to choose from, all promising solid returns. However, most funds fail to beat their benchmarks and peers over time.

As an investor, you need to analyze the performance and attributes of a fund thoroughly before investing your hard-earned money.

Choose the right benchmarks

The first step is to select appropriate benchmarks to compare the equity mutual fund against. For equity funds in India, common benchmarks include the Nifty 50 index for large-cap funds, Nifty Midcap 100 index for mid-cap funds and Nifty Smallcap 100 index for small-cap funds. Choosing a benchmark that closely matches the fund’s investment objective is key.

Check the long-term performance

Evaluate how the fund has performed over longer time periods of 5-10 years or more. Long-term performance shows how the fund has navigated different market cycles. Look for funds with returns that have consistently beaten the benchmark over long periods. Beware of funds that have done well only in recent years due to short-term market movements.

Review risk-adjusted returns

Don’t focus only on absolute returns but also on the risks taken to generate those returns. Check the fund’s risk metrics like standard deviation and Sharpe ratio. Standard deviation measures fluctuations in the fund’s returns. Lower SD means lower volatility. Sharpe ratio evaluates return per unit of risk. Higher Sharpe ratio is better as it means the fund has generated a higher return for the amount of risk taken.

Analyze performance during market downturns

See how the fund has performed during market downturns like 2008 financial crisis or 2020 COVID-19 crash. This shows if the fund has been able to limit losses during difficult times. Choose funds with lower drawdowns as they have experienced smaller loss of value during market declines, indicating a defensive investment approach. 

Compare

Compare the fund’s performance and risk metrics to peer funds in the same category. This helps determine if the fund has outperformed or under performed most similar funds. Look for funds that have consistently ranked higher than peers over long-term periods. Short-term out performance could just be due to luck.

Check portfolio management

Review the equity mutual fund’s investment approach and portfolio turnover. An experienced fund manager with a consistent investment process is more likely to outperform over the long run. Also, lower portfolio turnover indicates a more buy and hold approach, which tends to lead to better performance.

Fees and expenses

Compare the fund’s fees and expense ratios to peer funds and category averages. Higher fees negatively impact returns over time and are a drag on performance. Look for funds with lower expense ratios unless there is clear evidence that higher fees have translated to higher returns.

Check outflows

See if the fund has experienced any significant outflows of money from investors. Large outflows force fund managers to sell securities to meet redemptions, impacting performance. They also signal investors are not satisfied due to poor returns or fund manager departures. In these cases, the fund’s future performance could be at risk.

Conclusion

Consider all these factors to determine if the equity fund is one of the best mutual funds around for your risk-return profile. No fund is perfect but look for a fund that has consistently achieved solid risk-adjusted returns over the long run, outperformed peers, kept a stable portfolio and fees, limited losses in difficult times, and not had substantial investor outflows. Past performance is no guarantee of future results, but these are good signs the fund is likely to continue doing well over the long-term.

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