How to get the best from equity funds

Mutual Funds | admin | December 14, 2011 at 12:29 pm

Many investors follow the strategy of picking up a few top performing equity funds and often end up investing in “flavour of the month” type of funds. Needless to say, they ignore the risks associated with some of these funds and put too much emphasis on the short term performance. The truth, however, is that for deriving long-term benefits out of equity funds, one has to look beyond the short term performance. While the importance of past performance in the investment process can not be denied, it's critical to put performance in proper perspective. While reviewing a fund's performance, one needs to not only look at performance relative to funds with similar objectives over the longer term but also the risk taken by the fund to deliver those returns.

Knowing what to expect in terms of returns and how to measure the performance is very important. Every investor hopes that funds in his portfolio do well at all times. In reality, the performance of some of the funds may slip depending on the nature of the fund and the market conditions. While there is no need to panic every time the stock market turns volatile, it helps if one is prepared to deal with such a situation. For an investor who follows a disciplined approach to investing, fluctuations provide opportunities that one time and casual investors miss out on. Therefore, if a fund losses ground in a falling market, it should not cause concern. However, if the fund goes down when others are going up, it should be taken as a warning signal. Remember, the consistency in the fund performance is the key to long term success.

Therefore, the core holding of a mutual fund portfolio should be the funds that are managed well and are consistent in terms of their investment strategies. So, avoid those funds that are showing very high past returns but are inconsistent performers over different time periods. Similarly, if you have sector funds in your portfolio, those might behave differently from broadly diversified funds due to their narrow focus. That’s why one must have a mix of funds in the portfolio. Though MFs themselves are a diversified investment vehicle, the right mix of funds goes a long way in further diversifying the portfolio.

Another thing to remember is that changing allocations to different asset classes as well as different types of funds based on short term performance can make the portfolio risky and inconsistent. Such investment strategies emanate from investors’ desire to make a quick buck and as a result the original asset allocation and the balance in the portfolio goes for a toss. An equity fund investor must know that market caps have a role to play in the kind of returns his equity portfolios might deliver and the risk or volatility that may have to be encountered while earning those returns. That’s because there is direct relationship between risk and reward. Therefore, the key to success is to balance these two in such a manner that one doesn’t lose sight of one’s risk taking capacity.

Another key aspect that needs to be closely monitored is the size of the fund. A fund can become victim of its own success. In other words, it can become too unwieldy to manage efficiently. Besides, a fund’s performance can suffer in case it outgrows its investment style. However, one needs to look at the fund size in the context of its nature and investment style. While a fund focusing on large cap stocks may not be impacted by the large corpus, a mid-cap fund where the success depends on how effectively the fund manager does the stock picking, it may force him to make certain compromises in terms of the investment approach.

Equally important are factors such as time horizon and the risk profile in the decision making process. Therefore, investors with lower risk taking capacity and/or short term time horizon must focus primarily on debt and debt related hybrid products. While doing so, they also need to keep an eye on the emerging interest rate scenario as it has a direct impact on the kind of returns they one can get from these funds. It is important to make appropriate selection out of a variety of funds offered by mutual funds under this category.

Last but not the least, investors shouldn’t get emotional about their investments. While it is essential to have a long term view on equity investments, one should hesitate to get rid of those funds that continue to under-perform even after a reasonable time period. Remember, waiting endlessly in the hope of better results can be a fruitless exercise.

Source: moneycontrol.com