How to Analyze Equity Mutual Funds

  • 15 Sep 2023
  • Read 6 mins read

Analyze Equity Mutual Fund

It is not just enough to invest in mutual funds and own mutual funds. You also have to analyse the funds and its performance at multiple levels. It does not matter whether the fund you are holding are equity mutual funds or they are equity linked savings schemes. The fund must be evaluated for its unique characteristics, portfolio quality, returns generated and its fit into your portfolio. This is true of equity and debt funds and such a critical evaluation has a special role in enhancing your equity mutual funds returns.

One of the important decision you take in your mutual fund portfolio is whether you should diversify with a large cap equity fund or whether you should take a higher risk with focused equity funds for the sake of enhancing long term returns. Most of the long term equity fund investments are a kind of trade-off between risk and returns and you must take the call that is best suited to your unique return needs and risk preferences.

When we talk of analysing the mutual fund, it is not just about performance, but a lot more. Here are some simple steps to go about it.


Basic steps to analysing mutual fund performance

These may not be exhaustive steps, but broadly that is what evaluating your mutual funds is all about.

1) To begin with, you need to analyse the performance of the mutual fund holdings. Of course there are different benchmarks for equity funds, debt funds, index funds, liquid funds etc. Funds are typically analysed based on comparison with peer group, comparison with the benchmark index and the consistency of performance. You don’t just look at returns but also at risk adjusted return measures like Sharpe, Treynor etc.

2) Analyse for consistency of performance. You don’t want a fund manager giving superhuman returns in one year and negative returns in the second year. You want relatively consistent returns over time. Also, focus on funds that lose least value in bad markets as they are the funds with character. The last thing you need is a fund manager shooting from the hip.

3) Analyse fund manager longevity. In fact, it is not just the fund manager, but the entire team comprising of fund manager, dealers, CIO and CEO that should be stable over time. The longer they work together the better they are in sync with the fund philosophy. If you are taking a 10 year perspective of a fund, you need a fund management team that has worked in tandem at least for 5 years, not just for 6 months.

4) Costs matter, so look for the fund with the lowest expense ratio. After all, low expenses give a fund a head start against similar funds with higher expense ratios. Even a 40-50 bps cost advantage can magnify substantially over a longer period. There are options like you can opt for passive funds to reduce costs since index ETFs and index funds have lower cost by default. In case you are not too keen on advisory support from the fund, opt for direct plans instead of regular plans to reduce cost. One more way to reduce implicit cost of fund management is to look for lower turnover ratio.

5) Always evaluate mutual funds in context. When you evaluate a fund, benchmark, it to the index. If your active fund is not beating the index on a consistent basis over the long term, then it is an absolute waste of time. You are better off sticking to an index fund or an index ETF since they can give you index returns for a much lower cost. Stick to an active equity strategy only if it justifies the additional risk.

Now for the litmus test. The final step in analysing the mutual fund is whether it fits into your portfolio requirement. Your portfolio requirement has 4 specific needs. Firstly, you want to maximize returns. Secondly, for a given return, you want to minimize the risk. Thirdly, you want liquidity available when needed. Lastly, it should be tax efficient. The mutual fund portfolio has to meet this most important final test.