A mutual fund is a professionally managed company that collects money from many investors and invests it in securities such as stocks, bonds and short-term debt, equity or bond funds and money market funds.
Mutual funds are a good investment for investors looking to diversify their portfolio. Instead of betting everything on one company or sector, a mutual fund invests in different stocks to try to minimize portfolio risk.
The term is typically used in the US, Canada and India, while similar structures around the world include the SICAV in Europe and the open-ended investment firm in the UK.
What information and risk parameters should you consider before investing in an equity fund?
Choosing an equity fund for your portfolio requires a methodical selection process that has two stages. The first is about you and starts by identifying the need for an equity mutual fund in your portfolio or your financial goal along with its time horizon, the type of equity fund investment, and an assessment of your risk tolerance. Once these three things are in place, selecting the suitable fund from those available is the next step in the process, i.e. the second stage.
The second phase therefore involves finding all eligible funds using a more qualitative approach by searching for certain information about the funds and analyzing various risk parameters. You should look for information about the portfolio of funds, vintage, fund managers, expense report, its benchmark, and how the fund has performed its benchmark over time.
When you look at the portfolio, you see how diversified it is in terms of sector allocation and stock selection. This can be assessed by the top 10 sectors and holding shares of the fund. When you look at the year, it gives you an idea of how many business cycles the bottom has endured. During a bull run, most funds do well, but how funds perform through a full cycle of bull and bear market phases is an indicator of portfolio resilience. The fund manager’s track record is closely linked to the fund’s vintage. You can look at the other funds managed by the fund manager to get a better view of their track record.
The expense ratio is an important indicator of how well the fund is managed operationally, which is different from the performance of the fund. Lower the expense ratio, the better it is for an investor.
Next, look at the main risk indicators of equity funds such as standard deviation and beta. The first gives you an idea of the fund’s volatility in returns or expected fluctuations in its returns. A higher standard deviation implies that you can expect higher volatility in the fund’s returns, i.e. the return is likely to fluctuate more in both directions (positive and negative) than the average expected return of the fund. Beta is an indicator of the fund’s sensitivity to market movements. Beta >1 implies that the fund’s NAV is more sensitive to market movements. As a result, the fund will increase more than the market during upward market phases and will also fall more than the market in bull market phases. Beta =1 implies that the fund’s NAV will move closely with market movement. Low-risk mutual funds usually have Beta <1.
Take some time for yourself or seek guidance from a financial advisor to gather information about funds and analyze them before making the final selection for your portfolio.