We have time and again stressed the importance of research when choosing any investment plan and this holds just as true for SIPs as it does for any other investment option. If you’re thinking that it’s a simple matter of looking at ratings and reviews, you might want to think again; it’s kind of the financial equivalent of using Wikipedia to do the research for your Master’s thesis. Not that there’s anything wrong with Wikipedia, it just gives you unilateral views on matters (much like ratings and reviews for mutual funds and SIPs).
Since choosing the right SIP to meet your financial goals is 60% of the battle, we thought it would be a good idea to try and define some of the factors you should take into consideration when choosing the best SIP for you:
1. Age of the fund: We have talked a lot about how investing in equity funds in the long term gets you the best returns so, as such, this is an important factor to consider. It is by far the most basic indicator of the reliability of a fund. This in no way means that you shouldn’t look at how a fund performs in the short term, it just means that you should take note of how the fund performs during different market cycles, in highs and lows (doing relatively better than the benchmark during both). Look for a fund that is at least 3-5 years old.
2. Risk: Risk basically refers to the deviation from an expected outcome, and the expected outcome essentially means the average of many outcomes. Risk is measured (yes, it can be measured) by Standard Deviation (SD or STDEV) and indicates the risk investors have been exposed to by the fund. Checking this number will help investors understand whether the risk profile of the fund matches their own. i.e. if there were two funds with the same returns but one took lesser risks, investors with a low-risk appetite would choose the fund that took fewer risks.
3. Past returns: This is an obvious one so let’s go over it briefly. These are numbers that you cannot overlook. Historical returns are the indicators of the successful management and profitability of the fund. It is not an absolute indicator but plays an integral role in establishing the market perception of the fund. Let’s be clear, though, that returns are but a single data point and your assessment of a fund is incomplete if it is based only on these numbers.
4. The AUM factor: AUM or Assets Under Management refers to the market value of the total fund or the assets the fund holds. It is an indicator of the success of the fund. The bigger the AUM, the higher the trading value. This simply indicates that a large number of investors have invested in the corpus already and what kind of operations they would be dealing with. It also gives you a bit of an idea of what the fees might be like for a certain fund.
5. An understanding of the expense ratio: In order to meet the expenses for running the fund (overhead expenses, administrative costs, etc), the AMCs charge a percentage of the assets gained to the investor. This ratio helps us understand the size of the fund. Relatively small funds need to have a higher expense ratio to meet their expenses while expense ratios fall on the lower size for funds with a larger corpus.
6. Portfolio turnover: Portfolio turnover refers to the rate at which new stocks are bought and old stocks are sold (this is also called portfolio churn). Each time the manager of the fund churns the portfolio, a brokerage fee has to be paid and this is generally charged to investors. Knowing this is important since the higher churn, the higher the risk taken on by the fund, increasing the volatility of the fund’s holdings, and the higher the expense borne by the investor.
7. Portfolio concentration: This is a simple one. Before you invest, it’s important to look at the concentration of the fund’s holdings. Having a high concentration of funds in any one type of stocks or portfolios means that the risk associated with the fund is much higher and such funds should only be invested in by those with high-risk appetites. In general, it’s a good idea to ensure that your fund isn’t putting all its eggs in one basket.
8. Exit load: Some of the AMCs levy a charge on investors if they exit a scheme within a certain time frame. This is known as an exit load (great title for an action movie, but not quite as fun). It acts as a disincentive to leave the fund before the lock-in period. You should check if the fund you’re interested in charges it before investing since exit loads are generally a fraction of the Net Asset Value (NAV) and eat into your investment value if charged.
9. Reputation and management of the fund: The mutual fund house is the entity that pools and manages the investment of the individual and institutional investors. A reputed fund house will provide you with safe investment options while giving you sustainable returns. What a star cast is to a movie, fund managers are to a scheme. They are the decision-makers on all investing options and will solely be responsible for the management of the fund. Hence they become very important in deciding the success of your investment. Reputations exist for a reason and there’s a lot to be learned from them.
These are just some of the parameters which will give you some perspective about a mutual fund, especially when it comes to choosing one that matches your investment objectives. If you want to be even more thorough than this, more power to you! By and large, our advice remains the same: mutual fund investments should be long-term in nature to mitigate any risk taken on and to help you generate healthy returns.
We highly recommend that you consult with a financial consultant before you invest.
