The Mutual Fund Show: How To Assess A Fund’s Performance

How investors can stay informed and shield themselves from impulsive decisions.

Thoroughbred racehorses round a turn after crossing the finish line in Louisville, Kentucky. (Photographer: Luke Sharrett/Bloomberg)
Thoroughbred racehorses round a turn after crossing the finish line in Louisville, Kentucky. (Photographer: Luke Sharrett/Bloomberg)

Mutual funds are popular among people for reasons like professional management, rupee-cost averaging through the SIP route and transparency. Yet, investors can be susceptible to impulsive decisions, including redeeming their investments at the wrong time.

Investors can access information pertaining to the markets and schemes on the websites of the fund houses. Additionally, they can view factsheets that get updated compulsorily at the start of every month, which give a detailed breakup of their portfolios and performance. This can help them make the right decision.

Comparing a fund’s performance with its peers or against a benchmark may be a good starting point, according to Tarun Birani, founder and director of TBNG Capital Advisors Pvt. “While getting into the performance side the most important part which we have to look into is the actual performance versus the relative performance,” he said on BloomergQuint’s special series The Mutual Fund Show. “The relative performance will tell you how I performed compared to the benchmark, that’s one way to look at it—and that gives you a picture of the category where you have invested.”

Amit Bivalkar, managing director and chief executive of Sapient Wealth Advisors and Brokers Pvt., suggested examining the quartile performance of funds—or a measure of how a fund has performed against its peers in a particular category.

“So, I think there are three important ratios one needs to consider—alpha, beta and standard deviation. Based on these parameters, a fund is given a quartile ranking,” Bivalkar said. “We have observed if you’re a consistent quartile two performer, then you end up becoming quartile one on a long-term basis.”

Watch the full show here:

Edited excerpts from the interaction

Tarun, in a nutshell how do you monitor the performance of a fund that you are invested in?

While getting into the performance side, the most important part which we have to look into is the actual performance versus the relative performance. Most of the times, let’s say I invested Rs 1 lakh three years ago and my Rs 1 lakh is let’s say Rs 1,10,000 only. So three-year annualized returns is, let’s say just 3% on an annual basis. This is my actual performance. But let’s get into the second part- the relative performance. The relative performance will tell you how I performed compared to the benchmark that is one way to look at it- and that gives you a picture of the category where you have invested. So, that is the way I look at investment returns that the benchmark where you have invested; that is very critical. Now, look at another parameter which is called rolling returns. So, rolling return again gives you returns for the long term irrespective of how it is performing on a basis of one year, three-year, five-years or so. So any calendar year return is very critical. I think we need to look at relative performance.

Amit, same question to you in a nutshell. What are the factors that you take into account when you’re monitoring the performance of the investment that you’ve done?

So, you need to look at quartile performance based on how the fund has delivered over the index as well as in its broad peer category. We have observed that if you are a consistent quartile two performer, then actually you end up becoming quartile one on a long term basis. So whether you’re investing through an advisor or you’re investing direct, what you need to understand is look at consistency rather than topping the charts for the fund performance. Look at the relative performance to the benchmark and look at the relative performance to the peer. It may at times happen that we might end up comparing a dividend yield fund with a value fund or a growth fund. So have the categorisation in mind, look at the relative performance and the performance of the fund vis-à-vis the benchmark of the scheme. I think we’ll look at that and consistency in a quartile two scenario.

Tarun, how do you monitor these? Why the parameters that you chose which the rolling returns are, trailing returns and then we’ll get on to the other factors.

So let me give a very small example of rolling returns and I shared that chart with the team. Let’s take the example of multi-cap funds and we have for multi-cap funds. While we look at rolling returns let’s say from a three-year basis, from last 10 years. So, mind you from the last 10 years, the three-year rolling return study will give you a picture of the consistency of this fund- what is the minimum return which this fund is generating compared to the category where we have invested and it is very critical that you compare it with the category. So once you get there, you know what is the minimum this fund is getting you compared to the category, then you get into the maximum median, then you get into the average part, as well as then you start seeing that this fund, in the rolling return data, how many times it is given 10%, 15% and 20% return- that again talks a lot about the consistency; whether it’s a high-risk fund, low-risk fund or a medium-risk fund. So this rolling return study is according to me one of the best studies whenever you are comparing funds. Looking at only the trailing return is not a great idea to look at performance.

Just a quick follow up, is it possible for an average investor to calculate rolling returns or does it come in the fact sheet? How does the person get the rolling returns?

So this data is available with many sites. If you search on Google, you will find on any scheme you are asking for you will get a rolling return. But yes, it’s not available on the fact sheet. One needs to really deep dive into it to get this data. The second important point is the calendar-year return. I can tell you this calendar return again can save a lot of misery for investors. So let’s say I look at last three-year performance of various benchmarks. Like Nifty has given 7% return in the last three years. Mid-cap index has given 1% return and the banking index has given -2% returns. While it is very easy to generalise that the mid-cap funds have not delivered more than (a certain level of) returns, but when you start getting into calendar year returns, then you start observing much more deeply because let’s say mid-cap as a category from 2018to 2019—we had all these SEBI issues with the mid-cap category, so due to that these two years were like a complete washout for the mid-cap category. But starting 2020, if you start looking at mid-cap funds, you will start realizing there is a stark change which has come in into the performance. So, my suggestion would be looking at returns more from a calendar-year return. This calendar information is available very easily. Every year calendar return of any fund you ask for is available very easily.

What difference would it make if I look at calendar year returns versus maybe a financial year return? I mean, the event that we’re talking about could have happened in between calendars or in between financial years as well, right? So, why this calendar year choosing?

So this is like checking your performance on every year basis. So, let’s say if I look at any ‘X’ fund and if I look at the calendar year return of that fund, I know year one, year two, year three, year four and year five. So in these five years; whether I’m a quartile one, quartile two or quartile three performer- because when you look at point to point return; let’s say if I look at last five year returns. In the last six months, I may be a great performer because a very speculative stock like DLF is a part of my portfolio. Due to that, I got the performance but when I talk about consistency I want my fund in the last five years, whether at least a quarile two or quartile one kind of performance is there or not. Calendar year return will give you that picture.

Amit, can I ask you to come in on one of the points and of course because you also mentioned the importance of checking what quartile the fund performance is, etc. Can you elaborate a bit?

So I think there are three important ratios what one needs to consider when he looks at performance. One is your alpha—alpha is nothing but excess return delivered over the benchmark. Then you have got something called beta and I’ll explain beta in a minute. Suppose the fund is a beta 1.2- it means that if the index delivers 10% this fund is going to deliver 12% either on the upside or on the downside. So the volatility of the fund is measured by beta; wherein if the beta of the fund is higher, it means that the fund is going to be more volatile on the upside as well as on the downside. So first one was alpha where you have excess returns over the benchmark. The second is your beta which tells you how much volatile this fund will be. The third is standard deviation. Standard deviation will tell you that from the median, how much does this fund fluctuate. So if you take a combination of all these three; and mind you people have these things in mind that this fund has performed well, therefore I should go out or this one has not performed well, so I should not put my money in. So it’s a very tricky situation. You should look at alpha, you should look at beta and then you should look at standard deviation and then arrive as to which fund you should actually invest in.

Can you give a small example of it so that people can understand what kind of importance would you give to what ratio if at all and how would it work?

So alpha is the excess return. Most of the times we try to give too much importance on alpha and because of that we end up trying to buy winners of yesterday. So if a fund has delivered great returns over the benchmark in the last year, we try and find out that whether I should put in more money. A simple example I’ll try to give you. Small-caps over the last one year have delivered stupendous performance. Now if you want to look at that and say that I want to put my money into small-caps today, probably then we are not doing justice to your risk profile. So then there comes a measure of standard deviation wherein how much has the fund moved from the average or from the median over long periods of time. So as Tarun said, over one year calendar returns or three year rolling returns, try to find out the standard deviation of the fund. The third one is the beta wherein what we try to say is that how much volatile can this fund be and can you stomach that volatility. So if the benchmark return is of one and if the fund is having a beta of 1.2, that means the fund is going to be outperforming by 0.2 or under-performing by 0.2 to the benchmark. And these ratios are available. These are printed in fact sheets so one needs to go through those ratios before actually coming to choose a fund.

Tarun I’ll come to you first. Nowadays I’ve seen funds send me the monthly portfolios of what they have bought into or sold into select funds at least; what is the portfolio looking like. How much of an importance do you give to this monthly monitoring as to what kind of stocks are they buying into, are they buying some risky names, etc.? Should people get in that kind of minutiae?

I see that one need not get into this process because otherwise you should get into stock picking yourself. If you have given your money to someone as senior as a fund manager, I think the monthly monitoring and all these getting into that process—I don’t think that is a great idea because then you may get biased and you may start taking some decisions which are not correct. I think this is very critical from a setting up investment objective point of view because most of the people don’t set up investment objectives very clearly and that’s where they get into this monthly monitoring. They start getting into too much of what is happening every month, this stock is moving or not, which stock has the highest portfolio holding- I don’t think that is required anyhow. What the most important part is whether there is a serious issue in terms of management of that fund, whether there is a fund manager change and all that. All those things are critical which are very fundamental to the fund. So, those factors need to be understood much more in detail and there are basically four P’s on the basis of which we look at performance. One is the parent- which parent that fund house belongs to, the people- what fund managers are a part of that, what is the performance and then the process. If these four parts on an overall basis is good, I don’t think one needs to get into all these monthly things regularly.

Amit, what about you aside of the observations that you made? Do you look at these monthly things and anything else that you look at to, from a fund monitoring perspective?

So more importantly, if the objective of the fund is defined and the fund manager is buying according to the objective, I think you don’t need to look at what is buying and what is selling on a monthly basis because over analysis actually leads to paralysis. We only get data at the end of the month. Yes, you can look at the turnover ratio of the fund as to how many times is it churning the portfolio in a year. What is more critical is to look at the turnover ratio because buying and selling in a fund, it can happen mid-month which might not get reported. So this might be something which you don’t want to look at into detail. As advisors we definitely have to look at it because whether it is adding position in a sector or a stock that’s our job, but for the investor- he needs to look at what is the objective of the fund, is the fund manager sticking to the objective and what is the turnover of the fund. Along with that on the monitoring side, one important thing is to also have a look at the expense structure of the fund. I think that is also critical when it comes to monitoring performances.

What are the ideal numbers for both of these, Amit? The expense as well as well as turnover? Is there an ideal number?

There is no ideal number but typically your turnover lies between 40%-50% of the portfolio. You look at 1.2-1.5 as the range when it comes to turnover, and when it comes to the expense ratio, I think actively managed funds are anywhere between 1.5%-2% and passively managed funds are anywhere between 0.3%-0.5%.

Tarun, do you want to add anything else?

Tarun: Yes, one more important part; let’s say we are talking about small-cap funds. So when you spoke about the monthly monitoring part, something like a category like small-cap fund, I think this is a part of a very tactical portfolio and again timing becomes critical in this category like a small-cap fund. So let’s say if you have started with hundred and your value is already 200, so I would definitely look at a monthly monitoring or something like a small-cap fund with a very tactical fund in my portfolio. That is not my core portfolio. There too, one can look at monthly monitoring, yes.

Amit: I just want one thing here that many times people get confused between absolute returns, annualised returns and compounded annualised growth returns. So I think investors have to look at CAGR return for one year performance while on 2, 3, 5 and10 years, you have to look at XIRR or IRR kind of return on the funds.

What’s this?

On the CAGR part, it’s only tells you like a compound interest what is my money moving and how is it moving year on year. XIRR actually gives you; if you have redeemed some money within the years of investment, the reinvestment returns also gets calculated when you do XIRR. So it would be better if we show this on a chart next time and then we can explain it in a better way. Absolute return is nothing but Rs. 100; if it is 200, then you’ve got 100% return. If it is on a five year period, the CAGR will show you something like 17 and maybe XIRR will show you something like 16.8. So, we can display that once we have a chart in front of us.

Now, everybody puts in the money but how about telling them, when to exit? Amit, let’s start off with you on this one.

I think you must exit because your target return is not the right strategy, but whether you have achieved your goal for what you had put your money in. Suppose Niriaj wants to buy a BMW in five years and he had invested and his corpus is ready in three years and his corpus is ready in three years although his goal was five years hence, I think he should take out the money. So if you are taking out money for spending or consumption, then it’s perfectly alright. If you have achieved your goal and you want to redeem money before time, then it is perfectly alright too. I’ll give you a small example on this. Suppose you have invested Rs. 20 lakh in a fund and suppose the fund has delivered 10% and you have got Rs 22 lakh with you; most of the times the mistake what people make is that they redeem the Rs 2 lakh which is the profit and they say that I have redeemed my money. Now just give me a minute to explain this.

They redeem those Rs. 2 lakh and probably they go into another fund or they keep it in the bank. Suppose the market cracks by 10% after they have booked the profits. The Rs. 20 lakh which is remaining in the fund will go down to Rs. 18 lakh. Now, if we had kept Rs 22 lakh as it is in the fund, there will be a difference of only Rs. 20,000 had he not booked the profits. Second thing is, if you redeem those Rs 2 lakh, what are you going to do with it is also important. Many times, you see that clients moving from one fund to other equity fund by booking profits in one fund and entering other equity fund because the NAV is less than the fund they are invested in. I think these are myths we need to break. So if you want to do any spending, if you want to consume something, if you have achieved your goal well before time, that is the way you should actually book your profits because after you exit, entry at a lower price which is a major reason of people, that is not possible at all times.

Tarun, let’s assume that my goal is not reached but surely there could be factors which should be taken into account to exit a fund even if my goal is not reached because maybe the theme or the story may have changed or something. So, are there things that one should keep in mind?

So, the most important factor we mostly look at apart from reaching the financial goal is first of all, the re-balancing factor. So as we have clearly defined while you are doing a suitability exercise, there is a very clear cut demarcation on the risk tolerance level. So let’s say if we have defined a 50-50 portfolio for a client and with the rise of the market this 50 becomes a 60%. In that case, a 10% re-balancing is something we strongly advocate. Always stay in your needs, if your defined risk tolerance is 50-50, please redeem that 10% and get out of that. That is one very strong reason I would recommend to exit a fund.

Second important reason would be the change in the investment strategy of the fund. Let me give you some real time case study which I have observed in many hybrid funds currently. So let’s say, in the last two years I have been observing many hybrid funds which have been taking excessive risk in their debt portfolio and they have been taking a lot of credit calls in the debt portfolio. So trust me, when I have looked at a hybrid fund my plain vanilla idea to look at hybrid fund was that I want somebody who is actively doing that re-balancing; 70-30 of the portfolio. But what I observed that 30-35% of the debt portfolio, the fund manager is taking excessive credit risk and that is something that was not my investment objective because I wanted to safeguard my 30-35%. So in that way, what I would look at is, put that Rs. 35 in a pure debt category and Rs. 70 into a pure equity category. So that is one very big learning which I had over a period of time that investment strategy changes whenever you see. Recently we had a multi-cap fund. I think in the last week we observed that SEBI had given a dictat that they will change the structure of mid-cap, small-cap and large-cap. I think one needs to get very serious about it because the mid-cap and the small-cap proportion of the portfolio will dramatically change with this change in the multi-cap category. So if something like that happens, we need to really look at the overall risk profile and there also the change needs to be looked at.

Amit: I have a different view on this. I think SEBI will not allow operators to front-run the mutual fund, and therefore, it would not happen that you will actually go and end up buying small-cap. Why you have not bought small-cap in a multi-cap fund is because the fund managers don’t want to buy a small-cap there. I think you will soon get fresh live from SEBI wherein you can either merge this fund with your large-cap or mid-cap or whether you can have a flexi-cap as a category which will open up. That was point number one. Point number two is, when you’re doing a re-balancing or asset allocation mind you, it is very difficult for a retail investor to do this re-balancing. If you have a large portfolio it actually makes sense to do this re-balancing. Because if you have a Rs. 5,00,000 portfolio invested 50-50 into equity and debt, suppose Rs. 2,50,000 have gone to Rs 2.75 lakh and that kills your asset allocation, I don’t think so you’re going to take the pain of shifting 25,000 rupees from equity to debt. If that money is for long term, then I don’t think so you need to do that because you will break the compounding in equity fund. So if your portfolio is large, then 100% I agree with Tarun that we need to have re-balancing as a strategy, but for retail put a straight jacketed formula- equity money for 10 years, 15 years, 20 years, debt money as an alternative to fixed deposit because post tax you will get a better return.

Is the argument about a hybrid fund taking excessively risky credit calls; a valid one though because you don’t want that to happen in your hybrid fund. You invested in a hybrid fund for safety on the debt side?

More importantly, it is what the front objective is. You will be comfortable having a veg Pulav and if you want a vegetable Pulav you don’t want to have chicken along with it. So if you want equity, you go for equity. If you want debt, you go for debt. Have your percentile ready and just go and sit tight in those funds for a long period.

Tarun, in the first answer you mentioned about how you would also look at a fund manager exit as a sign of whether or not to stay in a fund or get out. Did I get you correct and why would you do that?

So a leader of your organisation is always a very critical factor while getting into anything you start with. So similarly for a scheme, any fund manager who is driving that fund is very important. This is very critical for a category. Let’s say, if I talk about a small and mid-cap category because the investment style of the fund manager is something which helps you generate that extra alpha. And when you see that exit of that fund manager happening, I think this is a very serious issue because you need to be careful that the kind of alpha with which expectation you are coming in, that might not hold true. Another guy coming in—that may completely change for you. So that is where you need to be very careful.

Amit, one last question to you. Anything else aside of the financial goal reaching part that you would be taking into consideration in a meaningful way in order to decide when to exit the fund?

For me, more importantly is whether the fund objective is continuous along with the said and signed. If I’m comfortable with the fund objective and I am going to stay put in the fund, I don’t even follow a fund manager exits. Why I will tell you because if there is a process and if there is a framework as to how the fund has to be managed, I think there are 7 billion people and nobody is indispensable here. Why does a Starbucks coffee taste the same across outlets? Why does a McDonald’s burger taste the same across outlets? It’s because there is a process and there is a framework. People might laugh at this that how can this be applied to investments. I think if you have the filter and the screener very much cut out, if you have the frame work as to what stocks you can buy, it’s just that the fund managers weight on which stock to buy and how much, I think that is more critical. So just trust the frame work and policies and the processes which a fund manager set out. If you agree with that, I will probably not have to exit even if the fund manager has actually quit.