How To Compare Two Mutual Funds?
Comparison is an integral part of our life. Be it our constant nemesis Sharma Ji ka beta or be it our “friend” who always has everything that we aspire. We all have parameters and factors with which we compare ourselves – salary, number of cars/bungalows owned or something else.
Similarly, there are factors that one should consider when one is planning to invest in mutual funds. There are n (n tending to infinity) number of options in the market for different goals and risk appetite of the investor.
So, how do you evaluate a mutual fund and make the choice? Read on to understand the same!
The expense ratio is the management fees that the fund charges – for managing your money and giving you the promised returns. This is generally a % of your investments, hence will impact your earnings from the fund.
Always chose the fund with a lower expense ratio, as it forms a smaller dent in your long-term earnings. The expense ratio of a regular plan tends to be more than a direct plan. This is due to the intermediary distributor in the value chain who would also need a piece of the pie.
For example, if a regular plan has an expense ratio of 2%, 1% goes to the fund and 1% goes to the distributor. However, in the direct plan, you would be charged only 1% which is attributed to the efforts of the fund. While comparing two funds, ensure that you are comparing direct-direct and regular-regular plans. (Apples to apples comparison)
SEBI mandates that each fund declare a benchmark, as it promises the investor that it would aim at achieving a return that is higher than the market. For example, ABC fund has declared Nifty 50 as its benchmark.
When the market rallies by 15% and the fund has delivered a return of 12%, it indicates that the fund has underperformed. However, when the market falls by 12% and the fund declined only by 10%, it indicates that the fund has outperformed the benchmark.
Hence, a fund should beat the benchmark during market upturns and should decline lesser than the market in case of a downturn. Hunt for funds that have consistently performed better than their benchmarks.
A typical thumb rule or the mantra in the financial industry is that – higher risk implies higher returns (Bank FD interest rate < Stock Returns). However, measuring the risk with only the returns becomes complex in the case of mutual funds, as there are factors such as sector allocation and other market conditions which affect the returns of the fund.
Alpha and Beta then come to your rescue. These Greek alphabets are your crystal balls which give you a fair idea about the risk involved. Alpha indicates the surplus return generated by the fund when compared to its benchmark. Beta indicates the volatility or risk involved in the fund.
For example, Fund ABC generated an alpha of 1 and had a beta of 1.5 whereas Fund XYZ had an alpha of 1 and a beta of 2. Then chose Fund ABC, since the risk is lower and the return generated is the same – in finance parlance, the risk-adjusted returns of Fund ABC > Fund XYZ.
Allocation Of Sectors Within The Fund
Consider a large-cap fund, SEBI mandates it to invest over 65% of its portfolio into large-cap companies. However, there is no restriction on the sector in this case. The fund manager may choose to invest in the pharma sector which has seen a boom post-COVID or could invest in the FMCG industry or the financial sector.
Sector exposure also determines the risk of the fund. Depending on your risk appetite, your preference for the sectors – accordingly do a right swipe on your fund match.
One last factor to consider would be a comparison against the Category average. What is the category you ask? Large-cap, mid-cap, small-cap, would classify as the category. The category average is the median of all the data of the funds.
This gives insights into how our fund has performed when compared to all the other players in the market. There could be cases where your fund has provided returns greater than the benchmark, but all the other funds in the category have also outperformed the benchmark.
Comparing with the average in the same class (Category) gives you another realistic indicator of how your fund has performed. For example, if the category average is 33% and your fund has given you returns of 39%, it indicates that your fund has outperformed its peers.
You can get detailed information on the performance and other aspects covered above on the EduFund app. You can start your investment journey with EduFund and even get advice from wealth experts to invest in the top mutual funds in the country.