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For some investors, a mutual fund fact sheet serves the purpose of looking back and reminding themselves about their investments and finding out where they are headed. For others it is only a publication that adds little value.
This is mainly because the second group of investors is unable to anlayse information from the fact sheet and primarily depends on their investment advisor to unravel it for them.
We believe investors should be self-reliant as far as evaluating their investment is concerned and that the fact sheet can help them on this front.
A fact sheet presents an ocean of information about the AMC (asset management company) and its various schemes. It provides valuable information, which is not only important for an existing investor but also for a prospective one. What an investor really needs to do is to extract the most relevant information from the fact sheet, which can help him in tracking his existing investment or decide upon his future course of action.
Also while analysing a fact sheet, investors usually place more importance on net asset value (NAV). They tend to ignore other equally important information points simply because they are not competent enough to interpret it.
We have highlighted some of the important points in a diversified equity fund's fact sheet that should draw the investor's attention.
1. Investment objective
The mutual fund's investment objective states what it aims to achieve e.g. capital appreciation, income generation among others. It could also inform the investor about the investment style of the fund and the kind of risk it is prepared to take for achieving its investment objective.
For instance, a broad investment objective like 'aiming for capital appreciation' means the equity fund has a flexible investment approach and is likely to do whatever it takes to clock capital appreciation.
A lot of equity funds in the past were launched with a rather minimal investment objective like 'capital appreciation'. It gave investors little idea about how the mutual fund planned to conduct its investment activity. Nowadays, of course, mutual funds have pointed investment objectives that give the investor a fairly good idea about how the mutual fund will go about its investments.
Ideally, an investment objective should be pointed enough for the investor to understand whether his own investment objective fits well with that of the mutual fund. For instance, an investment objective that states that the fund will 'attempt to generate capital appreciation by investing significantly in the mid cap segment', it tells the investor that it is likely to be a high risk -- high return investment. If the investor has the risk appetite for such an investment he can consider investing in the fund.
2. Portfolio diversification
Portfolio diversification can be broadly explained under two categories:
a. Top 10 stock holdings Concentration levels in the top 10 stocks reveals a lot about the investment approach of the fund. In our view, if the top 10 stocks of a diversified equity fund account for over 40% of the net assets then the fund should be regarded as concentrated as opposed to being diversified.
A concentrated portfolio is usually a candidate for market volatility. While it may generate above-average growth during a market upturn, it will be a sitting duck during the downturn.
b. Sectoral allocation This is another area that deserves a close look. A diversified equity fund is expected to be diversified across several sectors. If a fund has invested heavily across a few sectors, it qualifies as a sectorally concentrated equity fund. This could expose the mutual fund to higher levels of volatility during market turbulence. Sectoral concentration works against the fund if a particular sector/ sectors in which it has invested significantly is not performing as per expectations.
Looking at the sectoral allocation becomes particularly relevant because we have observed that equity funds are often well diversified across the top 10 stocks, but are heavily concentrated across a few sectors. During a market downturn, these funds tend to do as poorly as other concentrated funds.
While on the surface, some funds might seem like they are sectorally well-diversified, a closer look might reveal otherwise.
For example, it is not uncommon to find that similar-natured sectors such as 'industrial capital goods' and 'industrial products' being shown separately in the fact sheet.
This makes the fund look more diversified than it actually is. That is why, while analysing sectoral allocation, similar sectors should be clubbed together.
Click here for Personalfn's fact sheet section
3. Fund Performance
This is the most popular criterion for most investors. All mutual funds publish NAV returns in their fact sheet across various time frames. For an equity fund it is important to analyse returns for a longer duration of 3 years or even more. That is because as an asset class, equities tend to unlock their potential over a longer time horizon.
An investor should ensure consistency of returns over various time frames. The best way to test the fund on this criterion is to check its returns over a calendar year as opposed to compounded annual growth returns (CAGR). The returns of the mutual fund scheme under review should be compared with other mutual funds from the same category across AMCs.
Another important parameter for judging the fund's performance is by scrutinising how it has faired against its benchmark index. Every fund has a benchmark index. For instance, equity funds are often benchmarked against BSE Sensex S&P CNX Nifty, BSE 200, CNX Midcap among others.
The index is a yardstick for evaluating the returns of the fund. A fund is expected to outperform its benchmark index across market cycles to qualify as a superior fund.
4. Loads and Expense Ratios
Fund houses normally disclose the load structure and expense ratios in the fact sheets. The loads and expenses have a bearing on the fund's performance. The fund's NAV is declared after expenses have been factored in. Hence, higher expenses for a fund can impact its returns adversely over the long term.
Similarly loads (entry/exit) are an initial cost that the investor has to bear at the time of investing in or exiting from the mutual fund. To get a fair idea, the investor should compare loads and expense ratios across various fund houses.
One important aspect that investors must bear in mind is that although loads and expense ratios have a direct impact on the returns, this cannot be the sole criterion for evaluating a mutual fund scheme. Other criteria like fund management style and performance should be given higher priority while investing rather than loads and expense ratios.
In other words, a mutual fund with an average track record but lower expenses should not be given preference over an expensive mutual fund with an impressive track record. In such a case, consider the higher expenses as the 'price' you have to pay for investing in a well-managed fund.
5. Investment objective Vs Actual performance
It is important to understand whether the fund was able to adhere to and achieve its investment objective/mandate. For instance, a lot of large cap equity funds tend to make above-average allocation to mid cap stocks when this segment witnesses a rally. Or a balanced fund/MIP (monthly income plan) may up its equity allocation to benefit from a stock market rally while ignoring the ceiling on its equity investments.
Always invest in a fund that treats its investment objective as sacrosanct and rigidly adheres to the same across time periods and market cycles. Investors must be wary of mutual funds that haven't adhered to their investment objective/style.
For a Free download of the latest issue of Money Simplified - The Youth Special Guide to Financial Planning, click here.
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