Factors Affecting the Performance of Mutual Funds
The process of purchasing a mutual fund can be complicated since it requires an investor to make informed decisions. Therefore, before investing, new investors need to learn about several important factors that affect a mutual fund’s returns. This would help them identify funds with the performance and risk levels that match their financial needs.
This blog aims to cover all the major factors that should be considered before an investor invests in a mutual fund.
Factors Affecting Mutual Fund Performance
A mutual fund is an investment option where a fund house gathers funds from various investors and invests that pooled money in different investment instruments in the market. These range from stocks, bonds, gold, and much more. The underlying assets and the percentage allocation of those assets in a fund determine its objectives.
There are numerous factors affecting a mutual fund’s performance and the potential returns it can generate. For example, a fund that has been giving good returns may show losses due to market conditions.
To generate good returns from your mutual fund investments, you need to evaluate the factors that affect fund performance. These are:
- Fund House’s Experience
As an investor, you are responsible for checking the competency of your choice of fund house. This is because the competency of a fund manager and his/her team is a major factor that affects a mutual fund’s performance.
Most investors want to invest in mutual funds because they either don’t know much about the stock market or do not have any time to monitor their investments constantly. That is why they rely on the fund manager to look after their money for as long as they are invested.
The fund manager is responsible for actively managing the fund’s portfolio after thorough research and analysis. The more experienced a fund management team is, the more competent they will be at making investment decisions. So, try to choose a mutual fund whose fund managers have a proven track record of managing investors’ money efficiently.
- Expense Ratio
The expense ratio is the amount of money charged annually by a fund house for managing a mutual fund. This includes the fund manager’s remuneration for managing the investors’ funds on their behalf.
Other than their remuneration, the expense ratio also consists of any charges that the fund house has to pay to distributors in some cases. So, the higher the expense ratio of your fund, the lower will be your net returns.
This is why SEBI had created a guideline where any fund house in India cannot charge expense ratio more than 2.25%. So, choose a mutual fund with a lower expense ratio to get better returns.
- Economic Changes
Economic changes refer to any social or political reason that can bring fluctuations in the economic outlook. Moreover, if you invest in a sector specific mutual fund and the government makes policy changes specific to that sector, then there is a high chance that your fund’s performance may get affected.
For example, if the government brings any change to the IT sector in India, then the stock prices of IT companies will fluctuate. The impact of such policies can be both negative and positive. Similarly, if the economy goes through a recession, many people tend to sell their fund units because they do not want to incur losses.
This is why you need to keep a close eye on the economic changes that are taking place in the country.
- Fund Cash Flows
Fund cash flow refers to the influx or outgo of cash for a particular mutual fund. For instance, there is Fund X in the market, and many investors start investing their money in that fund. Now, the fund manager will have the financial cushion to make better investment decisions.
As a result, if the cash flow for a particular mutual fund is positive, then you can try investing in the fund because it will potentially give you better returns. However, in another scenario, when too many investors start to pull out from a particular mutual fund, the fund house will be forced to sell off these securities, resulting in the fund’s poor performance.
- Assets Under Management (AUM)
AUM is the size of the mutual fund or the total market value of the investments that particular mutual fund handles. The AUM is one of the factors that can affect a mutual fund’s performance. Therefore, a good fund management team will always try to keep the size of the fund large enough until they can manage it without any hassle.
If it is too large, the fund becomes hard to manage as the manager has to make large investments; if it is too small, then the management team will not be able to diversify their holdings properly. That is why the AUM should be well balanced to generate good returns.
Factors to Consider When Selecting a Mutual Fund Category
When selecting a type of mutual fund, you need to select an appropriate one whose investment objective aligns with your financial goals. Given below are certain factors which you should take into consideration while selecting the right mutual fund category:
- Financial Goals
Before you invest in a mutual fund, be it debt or equity-oriented, you need to know what you are investing for. You also need to know what goals you wish to fulfil with the returns of the mutual fund.
Once you know your goal, it will allow you to assess the time frame and expected returns that you need to achieve it. For example, you may have short-term goals like planning a trip or purchasing a designer bag, or long-term goals like accumulating funds for retirement or a new home.
Both investment objectives will have different types of mutual fund categories that will help you reach them.
- Time Horizon
After knowing the goals, you also need to know how long it will take you to accumulate enough wealth. Therefore, it would be best to consider how long you need to keep holding your investments in the mutual fund to reach your financial goals.
Some mutual funds require you to stay invested for months, while others require a time horizon of at least three years. This is why it is important for you to decide the time horizon for your investments.
Usually, equity funds require you to stay invested for a long time, while debt funds have a shorter investment horizon. Historically it has been observed that the longer you hold your investments, the higher returns you tend to get. For short-term goals, it is important to choose a mutual fund that is less affected by market-related risks.
- Risk Appetite
The last component you need to keep in mind while choosing a mutual fund category is your risk appetite. This refers to your capability and desire to bear the market-related risks. In this regard, SEBI has instructed all fund houses to display a ‘riskometer’, which makes it easy for investors to do a risk analysis.
According to past performance of certain mutual fund categories, investors with little appetite for risk of losses can invest their money in low-risk debt funds like liquid and overnight funds. On the other hand, people with high-risk tolerance can invest in high-risk equity funds for high potential returns.
It is important to understand the above-mentioned factors that affect mutual fund performance before investing. These will help you assess a fund’s potential to deliver returns in-line with its investment objective. Furthermore, you should research the market conditions and your risk appetite and set goals before you start investing.
Frequently Asked Questions
What is the NAV in mutual funds?
Net Asset Value (NAV) determines the market value of a unit of the mutual fund. This value changes daily, and investors should keep an eye on their mutual fund’s NAV to evaluate their fund’s performance. The NAV changes depending on the performance of the underlying assets of the mutual fund portfolio..
What are the modes through which I can invest in mutual funds?
Investors can invest in mutual funds in two ways. The first is SIP, and the second is a lump sum. In a Systematic Investment Plan (SIP), the investor will have to pay a predetermined sum of money monthly, quarterly, or every six months at a predetermined date.
Conversely, a lump sum is a one-time investment that an investor makes at the beginning. You can start investing via SIP with as low as Rs 100, but you will have to invest a considerable amount of money in a lump sum.
What are Liquid funds?
Liquid funds have a high level of liquidity and are perfect for investors with very low risk tolerance. These funds have a maturity period of 91 days. Liquid funds invest their total corpus in short-term fixed-income securities like treasury bills, corporate papers, etc.
What is a lock-in period?
Mutual funds can have a lock-in period; however, this does not apply to all mutual funds. It is a period in which the investor is not allowed to sell or redeem their fund units. For instance, Mutual funds of ELSS category have a lock-in period of 3 years, so if an investor had invested in an ELSS on January 1, 2019, then the investor will be allowed to redeem his fund units after January 1, 2022.
What is a benchmark in mutual funds?
Benchmark refers to certain parameters based on which investors can evaluate the performance of their funds. Sensex and Nifty are some stock market indices that act as benchmarks to measure the performance of certain equity funds.