K Ramalingam explains the three most powerful signals that indicate your mutual fund's performance
Illustration: Dominic Xavier/Rediff.com
All of us love a winner. It is a psychological need perhaps that gives us faith and confidence in the choices we make. But then, just as every day is followed by night, crests have troughs, and rise has fall, good performance is pitted against underperformance.
Life needs to balance and mastering the ups and downs is the key to every win.
As investors in the financial markets we need to cope up with underperformance. Handling underperformance in an able manner will ensure that the financial goals are not jeopardised.
Analysis and constant review of investments are two troubleshooting techniques that will help in detecting the trajectory of an underperforming mutual fund.
By remembering the golden rule – past performance is no guarantee for future returns, investors can get ready to monitor and analyse the performance of mutual funds on a regular basis.
Here are three powerful indicators that need to be kept in focus:
Indicator # 1: Strategy check
When a mutual fund slows down or does not perform as expected, look at it closely and analyse it.
Trending strategy vs time tested strategy
It is likely that the mutual fund manager is following a time-tested strategy that may not be in sync with the current trends but could prove to be vindicative over time. This would be similar to the strategy that some managers adopted at the time of the dot com boom in the 1990s by choosing to go with value-leaning mutual funds.
Check mutual fund's history
Delve deeper into the mutual fund's history. Investigate why it is losing steam and whether the mutual fund is experiencing a temporary crisis much like the sudden burst of mid-air turbulence faced by aircrafts during bad weather patches.
Is the same mutual fund manager continuing?
Often investors exit a mutual fund abruptly and then find that the same has generated bigger returns than before. So it is necessary to check and see if the same mutual fund manager is continuing and it is possible that his strategy will yield better results in the long run when compared to its peers.
Indicator # 2: Performance reality check
Underperformance over short period or long term?
Researching and investigating a mutual fund can be a long-drawn exercise. It would be needless for the investor to investigate short-term bouts of underperformance; rather a concerted attempt should be made to carefully examine the mutual fund's underachievement over a long period of time.
Underperformance when compared to peers
Particular focus should be on the mutual fund's performance during the period when it was expected to do well but did not.
It is possible that a particular mutual fund was chosen due to its resilience and consistency during market downturns however it is found that it lost more than its peers during such a situation.
This may thus be the right time to exit the mutual fund. The mutual fund may still be good but may not fit into the plans of the investor.
Have you checked the consistency?
While carrying out this analysis there might be a situation when a mutual fund is found to have performed badly in the most recent past year and is lagging behind its peers currently. However when the same mutual fund is checked for consistency over a three-year period, it might turn out to be one of the best overall.
It is therefore imperative to remember that assessing a mutual fund for too short a period could prove to be misleading.
Indicator # 3: Picking the right parameters for performance check
While it would be acceptable to lag behind other mutual funds in the short run on the performance perspective, it could be disheartening to see the chosen mutual fund fall behind consistently on a year-on-year basis for a few years at a stretch.
However, utmost care should be taken for selecting appropriate benchmark and relevant peers while comparing.
It may so happen that the investor removes a particular mutual fund and later finds that the parameters and peers selected are mismatching and the mutual fund just knocked out was actually a good one.
For instance, a mid-cap mutual fund should never be compared to a flexi- or large-cap mutual fund.
Similarly, such mutual funds should not be compared to the performance of the Sensex but with the performance of the more appropriate BSE Midcap index.
Proper comparison of mutual funds will yield relevant results only when data analysis is carried out over a reasonable, acceptable timeline and is also accompanied with the understanding of the mutual fund strategy followed by its managers.
Just because a mutual fund is not at the top of the table in the performance chart does not mean it is an under achiever.
Ramalingam K, an MBA in Finance, is a Certified Financial Planner. He is the Director and Chief Financial Planner at holisticinvestment, a leading financial planning and wealth management company