Compare Mutual Fund

Why Do You Need to Compare Mutual Fund Schemes?

Investors are spoilt for choice when it comes to choosing which Mutual Fund to invest in. While the three broad choices of Equity, Debt, and Hybrid Funds seem simple enough, there are currently over 2000 Mutual funds in India that investors can choose to invest in. This is because each of the 3 categories has multiple sub-categories with multiple Fund Houses offering similar funds.

While having options to choose from is definitely a good thing, having too many options can make fund selection quite difficult. Also considering that investing involves a long-term commitment using your hard-earned money, choosing the right Mutual Fund is critical for achieving long-term goals. This is where comparing types of mutual funds can help you select the right schemes to invest in.

Having a clear idea about how to compare mutual funds performance and other features can help investors choose schemes that are in line with their investment goals and help them design an investment portfolio that minimizes overall risk and maximizes returns.

How to Compare Mutual Funds?

• Comparing Mutual Funds: Different Parameters Available
• How to Compare Mutual Funds the Right Way
• The Right Way to Compare Equity Mutual Funds
• Comparing Debt Mutual Funds: Additional Criteria

Comparing Mutual Funds: Different Parameters Available

There are many different parameters that are available and are used while comparing Mutual Funds. There is the list of the most commonly used ones:

Returns

This is by far the most common criteria used to compare mutual fund schemes. In most cases, prospective investors look at the 1 year, 3 years, and 5-year returns of different schemes to compare them.

Returns Compared to the Fund Benchmark

The second criteria which are most often used are how the fund has performed against its benchmark. All Mutual Funds are benchmarked to a particular index and this data shows how much more or less the fund has delivered compared to that index.

Expense Ratio

The Expense Ratio is the annual percentage the fund house charges you for managing your money. There is a ceiling set by SEBI on how much AMCs can charge. AMCs can charge whatever they want as long as they don't cross the upper limit defined by the regulator.

Risk Measures

There are 4-5 key risk measurement ratios that are used to compare mutual funds:

• Standard Deviation - It is the measure of fund volatility. The standard deviation shows much the fund returns have moved up and down from their average in the past
• Sharpe Ratio - This ratio shows how much extra returns are being generated for the additional risk being taken by the fund
• Sortino - This ratio is a modification of the Sharpe Ratio that uses the downside deviation instead of the total standard deviation of the mutual fund. Sortino Ratio is used to determine the downside volatility risk of the mutual fund.
• Alpha - Alpha indicates the ability of a mutual fund to generate higher returns than its benchmark Index.
• Beta - Beta indicates the extra risk that a mutual fund is taking to generate returns that are higher than its benchmark Index

Portfolio Level Information

This can be divided into two types. Ones that give an overall view and ones that give a granular view:

• Allocation Across Market Caps - This section shows the Large Cap, Mid Cap and Small Cap allocation of the Equity Mutual Fund.
• Number of Securities - These are the number of securities that the mutual fund is holding according to the details published in the latest Factsheet.
• Average Maturity - This is only applicable to Debt investments and helps determine the interest rate sensitivity of a scheme. Average Maturity is the weighted average of how long it will take for all the bonds in a mutual fund portfolio to mature.
• Modified Duration - Modified Duration is also a measure of the interest rate sensitivity of a Debt Mutual Fund. It shows how much the price of a debt investment will be affected by a change in interest rates.
• Yield to Maturity (YTM) - The YTM data of a debt mutual fund indicates the potential returns that can be generated by the scheme. It also indicates the overall quality of Bonds and Money Market instruments included in the fund's portfolio.
• Portfolio Holdings - This section shows the sectors and companies the fund has invested.

How to Compare Mutual Funds the Right Way

With so much information available, it can be difficult to figure out what to compare and how to look at the data. However, it is imperative that you compare mutual funds the right way. That's because using the wrong method of mutual fund comparison can lead to you picking the wrong fund for yourself.

But before we go into the right way. There are two thumb rules you need to follow.

Thumb Rule 1 - Compare Funds Investing in Same Asset Classes

This is important for you to do an apples-to-apples comparison. For instance, if you pick a debt fund and equity fund, then the comparison will be of no use. To make sure you do this, start by defining your investment horizon. Look at equity funds for investment horizons of 5 years or more, hybrid funds for 3-5 investment horizons, and debt funds for less than 3-year investment horizons.

Thumb Rule 2 - Look at additional parameters while evaluating Debt Funds

While there are some common things across all fund types you can look at, for debt funds, there are some specific things related to portfolios you need to evaluate. More on those parameters later.

The Right Way to Compare Equity Mutual Funds

a. Compare Long-Term Performance

In the case of Equity Mutual Funds, it is always advisable that you compare the 5, 7, or even 10-year returns of schemes as part of your investment selection process. This is because while the short-term performance of Equity Funds is prone to volatility, the ability of these Mutual Funds to grow your wealth in the long term is unmatched.

b. Don't only Look at Returns. Look at Consistency of Returns

Using only the past returns to compare Mutual Funds is not a good practice as returns over a period of time could be because of a few bouts of extraordinary performance. That's why it is important to look at the Consistency of Returns in order to accurately compare Mutual Fund performance.

Consistency of Returns refers to the ability of a Mutual Fund to deliver the same level of returns over a medium and long-term horizon. Between two funds with the same returns, a consistent fund will be a better investment as it will increase the probability of you getting those kinds of returns and also have peace of mind.

c. Compare Downside Protection of the Funds

Markets are prone to periodic volatility and during these volatile times, your investment can see a fall. So while high returns during market bull runs is definitely an important criterion to consider, you should also check the downside protection provided by a Mutual Fund.

A Mutual Fund that offers good downside protection ensures that your investment losses are minimized in case of a market correction.

d. Compare Fund Performance to the Right Benchmark i.e. Category Average Returns

Category Average is the median of returns posted by all the Mutual Funds in a specific category across time periods. When you are investing in an actively managed fund, you are not looking to beat the index the fund has benchmarked itself to. You are looking to earn higher returns than what most funds of the same category are delivering. Moreover, most funds don't follow the stock allocation as done in the benchmark index. So the comparison becomes all the more futile.

e. Look at each Risk Measure in relation to others

As mentioned earlier, there are 4-5 key risk measures, and looking at them individually will not tell a great deal about a fund and hence comparison with another fund will become futile.

For instance, take the example of the Sharpe Ratio. Sharpe Ratio tells you the fund's ability to deliver risk-adjusted returns. The higher the Sharpe Ratio the better. But there is a catch. Sharpe Ratio uses Standard Deviation (another risk measure) as its denominator. So a fund with a higher Standard Deviation will need to earn higher returns to have a high Sharpe Ratio. So look at the overall risk measures to understand the risk of a fund and then compare it with the risk of other funds you are considering.

f. Use Portfolio Details to Understand Industry and Stock Concentration

The portfolio details of an Equity Mutual Fund scheme allows investors to see the various sectors and specific stocks that the scheme has invested.

In the case of Debt Mutual Funds, portfolio details include information about the various Bonds and Money Market investments that the scheme has invested in. Since mutual funds choose their investments based on their unique investment strategy, 2 funds within the same category can have investments in several different stocks or bonds. If a mutual fund has a large portion of its portfolio invested in a specific stock/bond or a specific sector, it will have a higher degree of concentration risk.

Comparing Debt Mutual Funds: Additional Criteria

The above criteria can be used to compare any two mutual fund schemes within the same category. But you need to consider a few additional factors when comparing two Debt Mutual Funds.

Debt Funds invest primarily in fixed return instruments such as bonds and money market instruments. As a result, Debt Mutual Funds can be significantly impacted by the quality of bonds a scheme is invested in as well as market factors such as changes in interest rates. So when comparing Debt Mutual Funds, investors need to consider two additional factors - Modified Duration of the scheme, and Credit Rating of the Portfolio.

Modified Duration

Modified Duration tells you about the level of interest rate risk you are taking. Modified Duration is the possible percentage change in the returns of the fund if the interest rates move up or down by 1%. So a fund with a higher modified duration has a higher interest rate risk vs. a fund with a lower modified duration.

Credit Rating of the Portfolio

The credit rating of the portfolio shows you the quality of borrowers the fund has lent to. A high credit quality portfolio means the fund has lent to borrowers which are financially strong and hence the credit risk i.e. the risk of borrowers not paying interest and/or principal amount is low.

Common Mistakes to Avoid When Comparing Funds

There are a few common and easily avoidable mistakes that investors make when comparing funds. Some of these are:

Comparing only Short Term Returns Data

Some investors only consider short-term returns of up to 1 year when they make a mutual funds comparison on the basis of performance. Short-term returns data can be misleading especially in the case of Equity Funds which are prone to high levels of short-term volatility. However, in the case of long-term returns, the impact of this short-term volatility of equities is significantly reduced. That's the key reason why it is always suggested that long-term returns of Equity Mutual Funds be considered along with other criteria before making an investment decision.

Considering Only A Single Criteria for Comparison

In some cases, investors base their investment choice based on only a single criterion such as returns or risk. This is not a good practice as using a single criterion like when you only consider the performance to compare mutual funds in India. Using just one criterion does not provide adequate information regarding whether a specific fund will make a suitable investment choice. Investors must compare mutual funds using additional criteria such as consistency of performance, risk, portfolio details, etc. to make an educated decision regarding whether a scheme is a suitable investment.