Due to their ability to deliver attractive returns, mutual funds are becoming a popular investment tool among many investors. However, with over 8,000 mutual fund schemes in the market, how does one decide which funds to invest in? Many mutual fund investors, both beginners and experienced, have a tendency to judge a scheme by its performance over the years and usually pick the one that has delivered good returns in the past. Is that a wise thing to do?
When you go through the performance history of a particular mutual fund, you must have read the disclaimer that says 'Past returns are not indicative of future performances'. What does this mean? Shouldn't you rely on a fund's past performance? What factors should you consider while picking a mutual fund scheme? These must be some of the questions that you, as an investor, must be having in mind. Allow us to answer those for you in the sections given below.
The past performance of a fund could be evaluated on the basis of:
A fund's historical performance is also a combination of many macro and micro parameters. Past returns of a fund should be used to judge the quality of a fund but not to predict its future performance. The fund's style of investing, its consistency, its strengths and weaknesses during different phases in the market, its volatility, and how all these factors have helped in delivering optimal returns, can be gauged from the historical performance of the fund.
Mutual fund experts advise investors not to base their investment strategies on the past performance of a fund as it can easily backfire. Many investors are misled by historical performances of a fund but it has been observed that many funds which have performed well in the past have not yielded satisfactory returns at a later stage. On the contrary, funds that have a history of delivering poor returns have delivered attractive returns in the future.
For example, in 2012, the Reliance Equity Fund had delivered returns of over 41% and was the top performer in the large cap category but if someone had analysed its historical returns in the previous year, they would have discovered that the same scheme was the worst performer in the same category based on its returns over the 1-year, 2-years, 3-years, 4-years, and 5-years period.
The same was observed in the case of the SBI Bluechip Fund which delivered returns of 38% in 2012 when its historical performance till December 2011 had been poor.
So, how can an investor predict the future potential of the fund? Simply by analysing the quality of the portfolio. This can be done by looking at how well a portfolio is positioned under various market conditions such as a bear market, bull market, defensive market, volatile market, etc., to generate returns. How a fund takes advantage of macro events to alter its asset allocation is one more quality to look for. This will help investors understand if a particular portfolio holds potential.
Having said that, a fund's returns can be determined by the forecasted returns done by analysts by taking market valuations into account and the nature of alpha generation of the portfolio. However, it is better for investors to not over-predict or forecast the returns as there is no sure-shot formula for predicting future returns. Instead, they should diversify their portfolio to minimise the risk on their investments.
As an investor, instead of just looking at the fund's past performance while buying mutual funds, you should look out for the below-mentioned factors:
Relying on the historical performance of a fund to steer your investment decision is not the best strategy. Funds which have performed well today may not do the same tomorrow and vice-versa. Hence, it is advisable that you look for the factors mentioned-above, align them with your investment goals, and make an informed decision on which fund to invest.
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