What are Mutual Funds and parameters to evaluate mutual fund performance

  • Posted By : reliancesmartmoney.com
  • Wednesday May 15, 2019

What are Mutual Funds ?

A mutual fund is nothing but a collective investment vehicle that enables investors to pool their money and invest in capital market instruments like equities, bonds, short-term money market instruments and other securities or assets as per their investment objectives. The underlying security types aka holdings form into a mutual fund portfolio which is managed by a fund manager appointed by the Asset Management Company (AMC).

In investing in mutual funds, the investor does not actually own the underlying securities but rather securities of the mutual fund. For example, if an XYZ mutual fund includes the shares of a particular company among others, the MF investor does not directly own the shares of the company but own the shares of the mutual fund. However, the investor will benefit from the appreciation in the value of the company’s shares.

The mutual fund comes out as a popular and reliable financial instrument that can help in achieving different financial goals. It offers the natural diversification allowing investors to spread their investment across multiple asset class and building their own investment portfolio with little or no knowledge of investing.

What is a unit in Mutual Funds?

A unit in a mutual fund company is also called a share or unit share. Ordinarily, mutual funds are open-ended, which means the company issues more shares whenever investors want to buy. The value of a unit is available on financial websites and fluctuates every day according to calculations made by the fund company. When you buy units in a mutual fund, your cost may include a sales charge. When you sell, you may also pay a fee in some cases.

What is Net Asset Value?

The total assets minus liabilities are called the net asset value, or NAV, and is usually computed every day at the close of business. The NAV of one unit equals the total NAV of the mutual fund divided by the number of shares. For example, if a fund's net asset value equals Rs. 10  lakh, and the fund has issued 1 lakh units, each unit is valued at Rs. 10.

What are Taxes and Risks in Mutual Funds?

You must pay annual taxes on the income from your mutual fund units unless they are in a tax-deferred retirement account. If the fund has earned capital gains by buying and selling securities, you may owe capital gains taxes. Share prices can go down as well as up, depending on the performance of the stocks or bonds in the fund's portfolio. If you need your money when unit prices are down, you may have to sell at a loss. Even if you sell your units at a profit, you'll owe capital gains taxes on the increase in share price.

Why should we track the Mutual Fund performance ?

Many novice investors choose to trust their mutual funds with their fund managers. Undoubtedly, the fund managers and advisors are useful and help you throughout your investment journey but it is preferable to have some knowledge of your mutual fund investments. After all, everything from your vehicle to body needs to undergo periodic health check-ups to perform well.

Making your first mutual fund investment is only half job done. Once it is done, it is equally important to keep track of the performance of your mutual fund that you must do time-to-time. However, you don’t need to fret over the performance on a daily basis but keeping a monthly or quarterly check and being aware of the overall progress is a good practice. Keeping tabs on the actual performance helps you decide whether to stay invested or exit from your investment. As the financial markets keep fluctuating in the influence of the overall economic conditions the risk profile of the portfolio change period. Hence, it is important to review and track the performance of the mutual fund portfolio to keep the risk profile intact.

How to evaluate the performance of a mutual fund?

  • Performance Ranking:
  • More than the recent or long-term performance of any scheme, it's ranking among peers should be looked at. To find out the ranking, you need to check out the quartile ranking which will show how the fund has performed quarter on quarter among its peer group. In quartile ranking, each quartile comprises 25% of peer group schemes. So one may select the scheme which has remained in top quartile most of the time. If at all you find your scheme going below 3rd quartile in a couple of consecutive quarters it hints that time has come to exit the scheme. You can find these rankings from the factsheets of various asset management companies (AMCs) and also on some mutual funds research websites.

  • Ratio analysis: 
  • Risk and return ratios are like standard deviation. Along with those ratios, one also should check out the performance ranking of the fund manager. You may check how often the fund manager has generated extra income for the fund as compared to the benchmark in last few quarters and also keep a watch on its consistency going forward.

  • Total expense ratio:
  • Expense ratio is a critical parameter to be looked at while selecting any mutual fund scheme. All fund management and distribution related expenses are borne by the scheme. This means high expense ratio will affect the fund's returns. Though SEBI has capped mutual fund's total expense ratio, still its best lower the better, unless we get some excellent return by paying higher expenses for fund management.

  • Fund manager’s tenure and experience:
  • The fund manager plays a crucial role in the fund's performance. Though it is a process-oriented approach, the fund manager is still the ultimate decision maker and his experience and points of view count for a lot. You should know who is the fund manager of the scheme and what is his past track record. You should also look at the performance of other funds which he is managing. If you find that due to change in the fund manager there is a considerable effect on the fund's performance which does not suit your risk appetite, then you may decide to exit.

  • Scheme asset size:
  • This parameter is different for debt and equity schemes. In equity, the comfortable asset size is hundreds of crores, in debt, it should be in thousands of crores as the investment value per investor is higher in debt funds. 90% of total assets under management (AUM) of the mutual fund industry are invested in debt funds, so your selected scheme assets should also have a considerable AUM. Less AUM in any scheme is very risky as you don't know who the investors are and what quantum of investments they have in this particular scheme. An exit of any prominent investor out of any mutual fund may impact its overall performance adversely, and the remaining investors in a scheme will have to bear the impact.  In schemes with larger AUMs, this risk gets minimised.

Key financial ratios in checking Mutual Fund performance

Financial Ratios


Portfolio Turnover Ratio

Measures the total fund trading activity and represents in the percentage of total mutual fund’s holdings changed over a 12-month time period.

Expense Ratio

Measures the total cost of managing a mutual fund.


Measures the volatility of the mutual fund against the benchmark.

Sharpe Ratio

Measures the mutual fund’s performance against the risk taken.

R-Squared (R2)

Measures the relationship between the portfolio and the benchmark.

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