With so many fund houses, so many fund categories & so may fund options in each category selecting the right fund to invest can itself be a humongous task. Knowing these fund evaluation parameters in layman’s terms & understanding their relevance will help you invest wisely.
The following are applicable to all funds:
Sharp ratio: This ratio shows the return per unit of the total risk taken by a scheme. The higher the value the better as it means that returns are commensurate with risk.
Standard Deviation (Total Risk): It is computed based on how much a fund’s return moves from its average return & thus represents the fund’s total risk. The lower the risk, the better it is.
Exit Load: The amount deducted by a fund when you redeem your investment before a stipulated period. A lower exit load is better because it is deducted from your corpus. However a higher exit load may not necessarily be bad as it deters investors from prematurely redeeming their investments. ou should also keep in mind the time period for which exit load is applicable (3 months, 6 months, 1 year).
Total expense ratio: This is the total expense charged by a scheme in a year. The lower the expense ratio the better it is because expense ratio eats into your annual returns.
The following are applicable to debt funds:
Credit Rating Profile: This indicates the quality of instruments a debt fund invests in. While government securities are risk free, corporate bonds vary from highest safety (AAA rating) to default (D rating). The higher the rating the safer it is but lower the interest rate. Some funds invest in lower rated bonds – (A rated or below) to gain from higher interest offered by these bonds.
Average maturity: It is the weighted average maturity of a debt fund’s holdings. Funds with high average maturity are more sensitive to interest rate fluctuations. They generate better returns when rates fall but fall more when interest rates rise.
The following are applicable to equity funds:
Portfolio Valuation (P/E Ratio): This is the weighted average price/earnings ratio of the stocks in a portfolio. Usually low P/E indicates value investing style while high P/E means growth investing. The former works well in a bull run while the latter in a bear market.
Alpha: It measures the excess returns generated by a scheme compared to its benchmark index. Like other risk adjusted return ratios the higher the alpha the better it is.
Beta (Market Risk): It measures a fund’s sensitivity to market movements. Beta less than one means the fund is less impacted by market movements (defensive) while more than one means rise or fall is more than the market.
Thus a combination of a higher alpha with a lower beta would be the best bet to take in equity funds.
Sabyasachi Paul has been associated with equity research and advisory on equity markets in India for over 9 years & currently heads the equity research desk of Eastern Financiers Ltd, Kolkata.He also manages a portfolio on the online platform Kristal. Find link to the strategy named ‘The Tortoise’