Your hard earned money is being invested into mutual funds by your advisor. While doing this, you are fully aware of the fact the investments are ‘subject to market risks’ and yet, very few people can actually determine whether or not their portfolios are doing well compared to market standards. There are many parameters to determine the performance of mutual funds, typically, most of them are retrospective. However, even though past doesnt’t dictate the future, it does give you a fair idea of what to expect.
Doing a thorough analysis of your mutual fund investments enables you to make financially secure decisions about your money. It also helps you determine your risk appetite and gauge the volatility of the market.
Without further ado, let’s jump into the top 7 factors that can help you analyse, monitor and gauge the performance of your mutual fund investments.
Top 7 Ways to Monitor your Mutual Fund Investments
1. Comparing the Fund to its Benchmarks and Peers
Every mutual fund typically has a benchmark against which its performance is measured. A healthy mutual fund is of course the one that routinely outperforms the benchmark of that category. You can also compare the performance of a specific fund against those of its peers i.e. funds of the same category. Doing this gives you an idea of the returns you should expect in the long run.
2. Alpha and Beta of the Fund
The margin by which a fund exceeds or underperforms against its benchmark, is called Alpha of the fund. A positive alpha indicates that the fund has outperformed the benchmark, while a negative alpha suggests underperformance. On the other hand, Beta of the fund measures the volatility relative to the market. A beta greater than 1 indicates higher volatility, while a beta less than 1 indicates lower volatility. This helps in understanding the risk associated with the fund.
3. Comparing Expense Ratio
While expense ratio may not feel like a big outlay in the beginning, in the long run it plays a huge part in deciding the performance of your investments. However, be warned that expense ratio alone cannot be a decision driver. It must be used in conjunction with other metrics to get a fair idea of fund performance.
4. Studying the Historical Performance of the Fund
Rather than studying a fund’s performance over the past or present financial year, investors must compare its performance over longer durations such as 1-10 years. This can help you determine the resilience of the fund against economic downturns and volatile market conditions. It also helps in understanding the success or failure of the fund’s strategy over time.
5. Measure the Portfolio Strength of the Fund
Correctly measuring the strength of the portfolio of the fund can certainly help you in predicting losses or returns from that investment. A well-diversified portfolio often spells good news as it helps shield you from market risks and balances your returns.A portfolio that covers funds in a single basket is typically more volatile and prone to bring affected my market fluctuations.
6. Determine Risk Adjusted Returns
Assessing the risk adjusted returns of a fund helps you compare the risks associated with investing in that fund, against the projected returns one can get from the fund. Following are the indices that measure the metric.
a) Sharpe Ratio
Sharpe ratio measures the fund's risk-adjusted return. It is calculated by dividing the excess return (over the risk-free rate) by the standard deviation.
A higher Sharpe ratio suggests that the fund is offering better returns for the amount of risk taken. A lower Sharpe ratio might indicate that the returns do not justify the risk.
b) Standard Deviation
Standard deviation quantifies the amount of variation or dispersion in the fund’s returns over a period. Similar to the Sharpe Ratio, a higher standard deviation indicates greater volatility and therefore higher risk.
c) Beta of the Fund
Beta measures the fund’s sensitivity to market movements. A beta of 1 means the fund's price will move with the market. A beta greater than 1 indicates higher volatility than the market, and less than 1 indicates lower volatility. Higher beta suggests more risk, but potentially higher returns. Lower beta implies less risk, with potentially lower returns.
7. Measure the PTR (Portfolio Turnover Ratio)
Measuring the PTR ie Portfolio Turnover Ratio involves assessing how many times the fund’s assets are bought and sold within a year. It is expressed as a percentage of its total assets. A high PTR indicates active trading, potentially leading to higher transaction costs and tax implications, which can reduce overall returns. Conversely, a low PTR suggests a more passive approach with fewer trades, resulting in lower costs and less frequent tax liabilities. PTR provides insight into the fund's investment strategy and its impact on performance.
FAQs
How often should I monitor the performance of my mutual fund investments?
While there's no strict rule, reviewing your mutual fund investment's performance at least quarterly is recommended. Short-term fluctuations are normal, but regular monitoring helps you identify long-term trends and make informed decisions.
What metrics should I use to evaluate mutual fund performance?
Should I compare my mutual fund's performance to the overall market?
What should I do if my mutual fund is underperforming?
How can I track my mutual fund performance easily?