How To Judge A Fund’s Performance

Wouldn't it be disappointing to invest in a large-cap fund that you thought was stable with moderate risk only to later realise that it is performing poorly. So, does it mean that you should exit the fund and invest in a different scheme? Not necessarily. There are a few simple methods by which you can judge a fund's performance and decide whether you want to continue investing in it.

Checking the historical performance data of a fund is a start but that is not the only way to judge a fund's performance. Here are a few other checks that you can perform to find out if the fund that you hold is doing well or not:

1. Judge a fund by its benchmark, not its returns: An equity mutual fund will not perform well in a falling market as it invests in stocks. Therefore, judging the equity fund to be a poor performer due to its low returns in a falling market is incorrect. Keep in mind, a fund aims to beat its benchmark. In that case, the fund's returns should be evaluated based on how the fund is performing in comparison to its benchmark. A fund is judged to be a good performer if it manages to beat its benchmark. Benchmarking funds will help you measure the performance of your fund against the market competition. For example, if you have invested in a large-cap fund that gives 30% returns against the benchmark's 25% then the fund has performed well.
2. Don't compare funds in different categories: Comparing the returns of large-cap funds with mid-cap funds and small-cap funds or other asset classes is not a fair evaluation of a fund's performance. It is wise to compare your fund with other funds in the same category, such as large-cap funds with other large-cap funds and mid-cap funds with other mid-cap funds. Each set performs differently. Hence comparing the returns of a large-cap fund when the stocks of large-cap companies are down with a mid-cap fund when the stocks of mid-cap funds are up, does not make for correct evaluation of a fund's performance. Instead, compare the fund's returns to its category average. The category average will show the average returns of all the funds in the same category across a time period.
3. Employ consistency measure to judge a fund's performance: If a mutual fund consistently beats its benchmark and the category average over a long period of time, it is an indicator of the success of the strategy implemented by the fund. In such a case, even if the fund performs badly once in the short term, you know that the fund house strategy will work and its performance will pick up again in the long term. Fund houses create strategies to make returns against the potential risks of a fund called risk-adjusted returns. Check the fund factsheet, which is available online, for the fund returns over the last 3 one-year periods to see how it has been performing, if the performance has been consistently good or bad.

A fund should consistently outperform its benchmark and category average. Apart from the above-mentioned methods, a few other checks such as the track record of your fund manager and the quality of stocks in your investment portfolio cannot hurt. A fund manager's expertise and past performance in the field are good parameters to measure his or her track record. Likewise, the quality of the stocks in a portfolio will reflect on the fund's returns and thus, in its performance. These checks can help judge a mutual fund's performance.