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When selecting a mutual fund, investors often rely on past returns to make the selection. But we all know that this is not the right thing to do. Investors should also look at the expense ratio, track record of the fund manager and the return consistency.
But, even these factors are not enough. At the recently held Cafemutual Ideas Fest 2022, the equity head of Canara Robeco MF Shridatta Bhandwaldar shared six factors that can help you make better fund selection.
1. Risk adjusted return
Bhandwaldar said that MFDs need to pull out the 10-year data of shortlisted funds and see how have the funds performed every time when there is a 10% fall in the market. "I give the highest weightage to risk adjusted returns. This is because it is very easy for fund houses to get carried away and build an aggressive portfolio. In such cases, the downside protection goes for a toss and the investor suffers if the bear market lasts for years," he said.
2. Portfolio turnover
Portfolio turnover is how frequently the fund manager changes stocks in the portfolio. As per Bhandwaldar, portfolio turnover is a good measure of the fund manager's conviction behind each change in the portfolio. "Of course, there will be changes in portfolio from time to time. But one needs to look at the frequency. Quick changes may indicate that the fund manager is adopting a trial and error method to build portfolio, instead of putting in a proper thought into it," he said.
3. Returns attribution - selection vs allocation
Different fund managers adopt different portfolio building strategies. As an MFD, you need to identify the strategy and see what works well in the prevalent scenario.
Bhandwaldar said that he prefers selection over allocation as the latter carries higher risk and it works only during particular market cycles and that too for short durations. "One should look at from where the returns are coming from. Is it coming from good stock selection or due to good performance of a particular sector?" he said.
"High allocation to a sector that's doing well is not the right approach. This strategy can lead to massive underperformance if the tide turns," he added.
4. Concentration of illiquid securities
We always tell investors not to look at the NAV alone. The underlying liquidity is more important, said Bhandwaldar, adding that MFDs need to look at three things — 1. what kind of stocks are there in the portfolio? 2. how is the liquidity of major allocations? and 3. what is the concentration level of every stock?
5. Quality of business and management in portfolio
In any business, ethics is one of the most crucial factors. Bhandwaldar also stressed on the importance of this factor. He said that MFDs should see what kind of businesses the fund has invested into and how good is the management team of those businesses.
"The quality of business and management defines what kind of returns you will get over a long period of time. If you get into shady businesses it will come back to haunt you at some point of time," he said.
6. Return scalability
The last factor, as per Bhandwaldar, is the ability of the fund to deliver good returns even when the AUM becomes large.
"When you start, it’s easier to manage as the manager can take concentrated bets. But that's not possible when the AUM becomes large,” he said.
The way to gauge the capacity of the fund manager to replicate the same performance on a larger scale is to look at the portfolio and see that there are no concentrated bets.
