How to evaluate funds suitable for your portfolio?
When this year’s Football World Cup began, most of the people bet on the big teams like Spain & Italy. Based on their previous performance people thought it was a safe bet. Even if they don’t become champions this time, they would always put on a good show. However, these people had no idea that they were in for a big surprise. Both Spain and Italy could not even make it to the second round of the World Cup. Did people overestimate the performance of the same teams that performed well in the previous World Cups or were they underestimating the potential of the lesser known teams that beat their heroes? Well, whatever may be the reason, one thing is clear, one can’t always depend on the past performances to select a winner.
Mutual funds are quite similar. There are funds that have a good history of returns and there are others that people don’t always notice but have a potential to outperform their peers. Investors who are fairly new to mutual funds would mostly fall for the numbers that a fund gained in the recent past. An experienced investor on the other hand would not invest his money on mutual fund just because it has performed well in the recent past. He would also do thorough analysis before he decides what to invest in and how much investment is ideal for a particular fund.
Mutual fund investment is something that one gets familiar with, in time. If you are new to this type of investment or don’t want to take a chance with your money, it is always a good idea to consult a financial advisor who has actual market experience. They can not only give you valuable advice on what funds are good to invest in but can also guide you in tracking your investments. Although it’s hard to actually find out how a fund will perform, however there are cues you can get based on its earlier performance.
Past performance is not predictive but indicative.
According to the world renowned value investor, the late Benjamin Graham, past performance of any mutual fund does not guarantee its future success but only ‘indicates’ what can be expected in the near future. The previous numbers give useful information that can help an investor identify the funds that may have a potential to give good returns in the future. The performance data however, is just for information and gives no guarantee that a fund will perform the same way in the future as well.
Look for consistency, not big numbers.
An investor’s first instinct is often to look at funds that are on the top of the index. The funds with a greater ROI will tempt most of the investors who will be willing to count on its recent rally on the charts. A fund that’s had a great run could also be an inconsistent one that could suddenly plummet. Checking the consistency of a fund is important to determine its chances of future success. An investor should find out how much a fund has diverged from its benchmark and its peers.
This will give the investor a fair idea of the ability of the fund to maintain a good performance.
Use annual returns for analysis, not trailing returns.
Trailing returns, or past returns of a fund within a specific time frame, do not give an investor a clear picture of the potential that it may hold under diverse market conditions. It only gives them very little information based on which the consistency of a fund cannot be determined. Annual return on the other hand, is the de facto method by which the performance of an investment can be compared. This type of analysis is beneficial because you are not investing in a fund simply because it topped the charts for a short period of time. Your analysis is supported by the annual performance of the fund in different market conditions. Trailing returns alone do not tell you how often and how much the fund has plummeted in the past financial year.
Note the strategy used
When doing your fund analysis, it is also vital to understand what kind of a strategy the fund managers used in order to sustain a good performance. Observing the pattern of returns of a fund manager’s strategy can help you get familiar with his/her investment style and can give you an idea about what works and what doesn’t. When assessing a strategy it is important to note how a fund performed during steep rallies and whether or not it was able to hold up well during market falls. It is also crucial to check how much the funds have diverged from their benchmark & peers. Another basic fact that you should keep in mind is that a good fund can be performing poorly simply because the strategy being used by the fund manager is not effective enough. There could also be an average fund that is doing really well just because the market seems to favour the stocks that it owns. Using past performance alone could be risky but when a thorough analysis on its strategy is done, it can bring out a better picture.
Analyse the risk
There is a certain level of risk involved in managing funds. To accurately interpret what drove the funds to achieve their numbers, one must analyse the risks that were taken by the fund manager. The risks could mean making a significant bet on a couple of sectors or individual stocks that could give good returns in the near future. However, taking risks don’t always work in your favour. There could be some funds that perform really well for a short time and have long spells of poor performance right after. It is when a fund stays at the top of the index during multiple trailing times that you should find out what type of risks the fund manager is taking. Once you get the hang of what and how risks should be taken, you can start experimenting with low value funds.
Past performance analysis is something that you tend to get good at with time. Investing needs a lot of patience and good luck. When investing your hard earned money it is always advisable to take professional assistance from a financial expert(s) who has the knowledge and experience to help you understand the risks involved in investing.
When this year’s Football World Cup began, most of the people bet on the big teams like Spain & Italy. Based on their previous performance people thought it was a safe bet. Even if they don’t become champions this time, they would always put on a good show. However, these people had no idea that they were in for a big surprise. Both Spain and Italy could not even make it to the second round of the World Cup. Did people overestimate the performance of the same teams that performed well in the previous World Cups or were they underestimating the potential of the lesser known teams that beat their heroes? Well, whatever may be the reason, one thing is clear, one can’t always depend on the past performances to select a winner.
Mutual funds are quite similar. There are funds that have a good history of returns and there are others that people don’t always notice but have a potential to outperform their peers. Investors who are fairly new to mutual funds would mostly fall for the numbers that a fund gained in the recent past. An experienced investor on the other hand would not invest his money on mutual fund just because it has performed well in the recent past. He would also do thorough analysis before he decides what to invest in and how much investment is ideal for a particular fund.
Mutual fund investment is something that one gets familiar with, in time. If you are new to this type of investment or don’t want to take a chance with your money, it is always a good idea to consult a financial advisor who has actual market experience. They can not only give you valuable advice on what funds are good to invest in but can also guide you in tracking your investments. Although it’s hard to actually find out how a fund will perform, however there are cues you can get based on its earlier performance.
Past performance is not predictive but indicative.
According to the world renowned value investor, the late Benjamin Graham, past performance of any mutual fund does not guarantee its future success but only ‘indicates’ what can be expected in the near future. The previous numbers give useful information that can help an investor identify the funds that may have a potential to give good returns in the future. The performance data however, is just for information and gives no guarantee that a fund will perform the same way in the future as well.
Look for consistency, not big numbers.
An investor’s first instinct is often to look at funds that are on the top of the index. The funds with a greater ROI will tempt most of the investors who will be willing to count on its recent rally on the charts. A fund that’s had a great run could also be an inconsistent one that could suddenly plummet. Checking the consistency of a fund is important to determine its chances of future success. An investor should find out how much a fund has diverged from its benchmark and its peers.
This will give the investor a fair idea of the ability of the fund to maintain a good performance.
Use annual returns for analysis, not trailing returns.
Trailing returns, or past returns of a fund within a specific time frame, do not give an investor a clear picture of the potential that it may hold under diverse market conditions. It only gives them very little information based on which the consistency of a fund cannot be determined. Annual return on the other hand, is the de facto method by which the performance of an investment can be compared. This type of analysis is beneficial because you are not investing in a fund simply because it topped the charts for a short period of time. Your analysis is supported by the annual performance of the fund in different market conditions. Trailing returns alone do not tell you how often and how much the fund has plummeted in the past financial year.
Note the strategy used
When doing your fund analysis, it is also vital to understand what kind of a strategy the fund managers used in order to sustain a good performance. Observing the pattern of returns of a fund manager’s strategy can help you get familiar with his/her investment style and can give you an idea about what works and what doesn’t. When assessing a strategy it is important to note how a fund performed during steep rallies and whether or not it was able to hold up well during market falls. It is also crucial to check how much the funds have diverged from their benchmark & peers. Another basic fact that you should keep in mind is that a good fund can be performing poorly simply because the strategy being used by the fund manager is not effective enough. There could also be an average fund that is doing really well just because the market seems to favour the stocks that it owns. Using past performance alone could be risky but when a thorough analysis on its strategy is done, it can bring out a better picture.
Analyse the risk
There is a certain level of risk involved in managing funds. To accurately interpret what drove the funds to achieve their numbers, one must analyse the risks that were taken by the fund manager. The risks could mean making a significant bet on a couple of sectors or individual stocks that could give good returns in the near future. However, taking risks don’t always work in your favour. There could be some funds that perform really well for a short time and have long spells of poor performance right after. It is when a fund stays at the top of the index during multiple trailing times that you should find out what type of risks the fund manager is taking. Once you get the hang of what and how risks should be taken, you can start experimenting with low value funds.
Past performance analysis is something that you tend to get good at with time. Investing needs a lot of patience and good luck. When investing your hard earned money it is always advisable to take professional assistance from a financial expert(s) who has the knowledge and experience to help you understand the risks involved in investing.
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