Top equity mutual funds in India

Top equity mutual funds in India

Before we talk about top mutual funds in India, we must also understand the process of arriving at these mutual funds.

There are thousands of funds and selecting 3-4 funds that meet your objective is a challenge.

Most investors have “look at the past record” approach for selecting equity mutual funds. This may not be a complete answer.

For all practical reasons, you should avoid sector based funds and international funds. Sector based funds expose you to unnecessary sector risk and international funds are able to deliver only when INR depreciates. Both these situations create a unique risk and may be avoided.

Although past performance is not the only factor it is still an important factor to consider. A fund should prove its merit over a period of at least 5 years. Therefore, a fund that is recently launched may be avoided.

Now that ground rules are laid, here are the aspects to look at closely while short-listing the funds. You have to source all the funds in specific categories i.e. large-cap, mid-cap, small cap, multi-cap and tax saving funds. If you do not perform analysis basis specific category of equity mutual fund, there may be an overlap of securities that will be detrimental to your portfolio.

Criteria no. 1: 5-years Alpha

In simple terms, how well the fund has performed better than the benchmark. A large-cap category can have the benchmark as ‘Nifty 50’ whereas others can have ‘Nifty 500’ as the benchmark. Any funds whose 5-year performance is less than the benchmark may be excluded. Think about it, if the fund manager is not able to beat the benchmark, the manager is destroying value rather than adding value to the investor’s portfolio. Basis the recent SEBI’s requirement to align mutual fund schemes as per the fundamental attributes, various mutual fund houses are combining schemes that have the similar fundamental attributes. This will make calculating alpha redundant for some time since good and bad schemes combined together may indicate above average performance but that may not be a correct assessment. SEBI circular

Criteria no. 2: Information ratio (IR)

Information ratio is a measure of the risk-adjusted return. Information ratio shows the consistency of the fund manager in generating superior risk-adjusted performance. Higher the ratio better it is. IR is expected active return divided by tracking error, where the active return is the difference between the return of the security and the return of a selected benchmark index, and tracking error is the standard deviation of the active return. IR calculation may be misleading due to the recent changes to combine mutual fund schemes based on fundamental attributes.

Criteria no. 3: Asset Under Management (AUM)

As a rule, you should probably avoid funds with assets less than Rs 100 crores simply because of the relatively higher expenses associated with small funds.

Small funds may not survive or may undergo changes in the objectives in the search for greater acceptance in the marketplace. Whether through asset growth or other factors, over time a fund’s return tends to move towards the average.

Criteria no. 4: Fund manager tenure

A fund manager manages a fund. He takes a call on what to buy and what to sell and also in what proportion. Fund’s performance is directly linked to the skill of the fund manager. Therefore, the tenure of a fund manager is an important factor to consider when selecting an equity mutual fund. When managers change, a wait-and-see policy is usually appropriate.

Apply these criteria’s to filter out relevant mutual funds. You will find only a limited set of mutual funds in each of the five equity mutual fund categories.

Here is a list of funds in each category after considering the recent combination of mutual fund schemes.

Large-cap funds

  • Aditya Birla Sun Life Frontline Equity Fund
  • SBI Bluechip Fund

Large-cap funds and mid-cap fund

  • Franklin Templeton India Prima Fund
  • Mirae Asset Emerging Bluechip

Mid-cap and small-cap fund

  • Franklin Templeton India Smaller Companies
  • DSP Black Rock Small and Mid Cap

Multi-cap funds

  • Mirae Asset India Equity Fund
  • Aditya Birla Sunlife Equity Fund

Tax saving funds

  • DSP Black Rock Tax Saver
  • Axis Long Term Equity

The list of the top mutual fund is not an end but rather only a starting point. Often people get too aggressive when the markets are moving up but having a mix of assets ensures a reasonable return in all seasons. A long-term first-time investor may also evaluate Index Funds with the lowest expense ratio.

You have to structure the portfolio in such a way that your overall investment portfolio suits your behavioural aspect. You don’t want to have a heartache due to portfolio fluctuations 🙂

How to select the right Mutual Funds ?

How to select the right Mutual Funds?

There are thousands of different schemes from various mutual fund schemes and selecting the best ones can sometimes get hard.

Most folks ask friends and family or research popular online websites to get the top fund recommendations and invest in the top-rated funds.

The biggest mistake that mutual fund investors can make, is selecting mutual funds only on the basis of past performance.

Then there are some who consider the star ratings given by various research agencies. These star ratings can be one of the factors to look at, but there are other important parameters that one should also consider before finalizing a mutual fund portfolio.

The most important step in selecting mutual funds is to first have an investment goal and timeline i.e. how long do you plan to stay invested in that fund to meet your goal.

A fund selection done without an investment goal may not give the best results. You should know the reason for your investment, how long you can stay invested and at what stage you will re-allocate / redeem before you make your first investment.

Once your investment objectives are finalized, you may evaluate a fund based on the following parameters:

1.) Performance Ranking

More than the recent or long-term performance of any scheme it’s ranking among peers is very critical.

  • Firstly, you must compare the mutual fund with its peer group.
  • Secondly, you must compare the performance of the scheme with its benchmark.

The fund, which has performed well in one quarter, may not perform well in the next quarter. Funds with a good long-term top quartile performance are far superior to a fund scheme, which has one top position and one bottom position.

2.) Total expense ratio

As a fund starts to do well it starts to attract a lot of investors, and as its assets increase it should keep dropping its asset management charges.

Look at well-managed funds with charges below 1.9% p.a. – there are many.

Though mutual fund’s total expense ratio has been capped by SEBI, still lower the fees, the better it is for you unless you get some extraordinary return by paying higher expenses for a specific fund.

3.) Fund manager tenure and experience

Fund managers play a very important role in the fund’s performance. Though managing a mutual fund is a process-oriented approach, the fund manager is still the ultimate decision maker and their experience and viewpoint count for a lot. You should know who the fund manager of the scheme is and what their past track record is.

If you find that due to change in the fund manager there is a considerable effect on the fund’s performance, which does not suit your risk appetite then you may decide to exit from that fund.

4.) Scheme asset size

The lesser the assets under management (AUM) in any scheme, the riskier it’s likely to be. This is because you don’t know who the investors in the scheme are and what quantum of investments they may have in that particular scheme. An exit by any big investor from the mutual fund may impact its overall performance and the remaining investors in a scheme will have to bear the impact. In schemes with larger AUMs, this risk gets minimized.

It is recommended to invest in 3-4 funds that match and/ or complement your investment objectives. This is to avoid dependence on any one fund and avert risks of market downturns.

In addition to these, there are some additional indicators, which you can look at if you are inclined:

Alpha

This is a measure of a funds performance with respect to the index. If an alpha is 1%, it means the fund has performed 1% better than the market performance.

Beta

This indicates the level of volatility of a fund with respect to the market index. The larger the beta of a fund, the more volatile it will be.

Information ratio

The information ratio (IR) is a ratio of portfolio returns above the returns of a benchmark – usually an index – to the volatility of those returns. The information ratio identifies whether a manager has beaten the benchmark by a lot in a few months or a little every month. The higher the IR, the more consistent a manager, with consistency being an ideal trait. Conversely, the lower the IR, the less consistency.

Standard Deviation

This indicates how much the current performance of the fund is changing its past performance. A high standard deviation may not be a good indicator for the fund.

Sharpe Ratio

This ratio indicates the source of a funds performance and how much of risk the fund was exposed to, to get higher returns. The larger a fund’s Sharpe ratio, the better will be its risk-adjusted performance.

While you may shortlist mutual funds based on the above parameters, it’s a good idea to have a financial advisor on retainer who you can use as a sounding board to discuss potentially good and bad funds.

What are Equity Mutual Funds ?

What are Equity Mutual Funds?

If you do not have the time or requisite skills to evaluate good quality stocks on your own, you can invest indirectly in stocks via equity mutual funds.

Every mutual fund scheme has a specific objective and invests in assets accordingly. Equity mutual funds invest only in stocks of various companies.

Most equity funds are created with the objective of generating long-term growth and capital appreciation. The investing horizon for equity products is also longer, given that equity as an asset class may be volatile, in the short term.

However, all equity funds are not the same and their investment objectives vary. Classification of an equity fund is based on the type of companies a fund invests in. Here is a broad category of equity funds you must be aware of:

Large-cap funds

Large-cap funds are, typically, the least risky among equity mutual funds. A large-cap equity fund invests primarily in companies that are among the least volatile as they are usually mature businesses.

Mid- and small-cap funds

These funds are riskier than the large-cap funds. They invest in smaller-sized companies that are in their growing stages. Since these companies are in their growing stages, their share prices can get volatile in an uncertain market. Their stocks typically rise more than large-cap funds in rising markets, but also usually fall more than large-cap companies in falling markets.

Diversified equity funds

These funds invest across various sectors, sizes and industries, with the objective of beating a broad equity market index. These funds feature lower risk as the benefit of diversification kicks in and are suitable for investors with long investment horizons. The underperformance of one sector or stock may be made up for by the out-performance of any one or more of the other sectors or stocks.

There are other categories of equity funds such as sector funds, thematic funds, and special situation funds. One needs to be careful while investing in sector-specific funds because if the entire sector underperforms, your fund will be badly hit.

Remember: Invest in equity mutual funds only if you can stay invested for long period of time. The longer you can stay invested, the greater will be your returns.

Why should you invest in a debt mutual fund?

Why should you invest in a debt mutual fund?

Debt or bond mutual fund schemes are completely different from equity mutual funds. Not only are they much safer but also the risk and volatility associated with them are also low. Therefore, their returns are also lower when compared to equity funds.

These mutual funds invest in government bonds, securities and other cash related products.

What are bonds?

Companies or state and central government bodies issue bonds to raise money for various projects. Let’s take the example of a government bond.

Every government needs money or capital for financing infrastructure projects and other needs. i.e. they need money to build roads, railways, hospitals, and other public utilities.

The taxes we pay as citizens are usually not enough to fund these initiatives. Regular taxes go towards regular expenditure including government official’ salaries, travel and other operational costs.

This is why they issue bonds. What it essentially means is that if you buy a government bond of Rs 1000, the government guarantees to return back your money after a certain period of time at a fixed rate of interest. Since governments usually don’t default on their loans, government bonds are considered as relatively safe investment options.

Types of bonds

The bonds are also of different types, namely short, medium-term or long-term bonds. If you have to build a highway, one will incur a large cost right now and the money will be recovered via tolls in the next 20 to 30 years. Thus the government will issue long-term bonds to fund such capital-intensive projects.

On the other hand, if the government requires capital to build schools or hospitals, the cost may be recovered in a much shorter time frame – and hence will issue short-term bonds.

Mutual fund schemes, which invest in, and buy and sell these bonds are known as debt or bond mutual fund schemes.

There are various bond funds, which can be used to meet specific financial objectives. Bond mutual funds invest in debt securities, money market securities or in longer-term debt securities, or a combination of the above.

Ultra Short Term Bond Fund or Liquid Funds

These funds invest in securities maturing in less than 1 year. The primary source of return is interest income. They seek to provide safety of principal and superior liquidity.

Suitability: Investment horizon of less than 1 year.

Short-Term Funds

These funds combine short-term debt securities with a small allocation to medium-term debt securities. Short-term plans earn interest from short-term securities, interest and capital gains from medium-term securities. The volatility in returns will depend upon the extent of medium-term debt securities in the portfolio. Short-term funds may provide a higher level of return than liquid/ultra-short term funds but will be exposed to higher risks.

Suitability: Investment horizon of 1-3 year.

Medium-Term Funds

These funds combine medium-term debt securities with a small allocation to longer-term debt securities. Medium-term plans earn interest from medium-term securities, interest and capital gains from medium-term and long-term debt securities.

Suitability: Investment horizon of 3-5 year.

Long-Term Debt Funds

Market interest rates and value of a bond are inversely related and any fall in the interest rates can cause a gain in a bond portfolio and vice versa.

Therefore in a falling interest rate scenario, when investors in most fixed income products face a reduced rate of interest income, long-term debt funds post higher returns. The extent of change in market prices of debt securities is linked to the average tenor (duration of investment) of the portfolio – higher the tenor, greater the impact of changes in interest rates.

Suitability: Investment horizon of more than 5 years.

For all practical reasons, creating a portfolio with a combination of ultra-short term debt fund and the short-term fund will meet the objective of most of the investors.

What is a mutual fund?

What is a mutual fund?

It is a pool of money collected from a large number of investors by a professional entity with an aim to invest in different avenues for a variety of purposes. These avenues could be equity, debt, gold, commodities, real estate and so on.

Presently in India, Mutual Funds are not allowed to invest in real estate directly, though they can invest in equity shares or bonds of real estate companies. Equity markets, debt markets and gold are the most popular asset classes that Indian MFs invest in.

The purpose of investment will vary according to the asset class chosen. Equity is usually a vehicle for long-term wealth creation; debt for some regular income and an attempt to protect your capital; and gold as an inflation hedge.

When do mutual funds work…

Unlike bank fixed deposits—where, whichever deposit you choose, you get a fixed rate of return—Mutual Funds don’t assure returns. The degree of risk varies from scheme to scheme. So, be mindful of which one you select. The good news is that risk is not a bad word; it means volatility and volatility can be managed.

…and when do mutual funds not work

MFs are not the right choice if you want guaranteed returns.Mutual Funds never guarantee returns; regulations prohibit them from doing so. Since they invest in equity and fixed-income markets, your money is subject to the volatility that these markets bring.

But since you end up taking risks, the chances that you earn returns higher than a typical assured-return instrument are also high. If you are certain that you need assured returns, avoid Mutual Funds.

Types of mutual funds

Broadly, there are four types of Mutual Fund schemes.

Equity

These funds invest in equity markets. They could either invest in large and well-established companies or medium- and small-sized companies. Some include a healthy proportion of both segments and are called multi-cap funds. There are thematic and sector funds as well, which invest in a few sectors or just a single sector, and are meant for those who have timely and informed views about the fortunes of select sectors.

Among the four categories of funds, equity funds are the most volatile. Use equity funds if your financial goal is at least five to seven years away.

Debt

These funds invest in fixed-income instruments such as bonds, government securities and short-term instruments such as certificates of deposit and commercial paper. Although they do not assure returns, they are less volatile than equity funds and are, therefore, used to earn regular income.

While liquid funds are least volatile (since they cater to investments of up to three months), bond funds rank high on the risk ladder since their underlying instruments mature after 3-5 years. Debt funds make money by managing credit risk and interest rate risk.

A credit risk is managed by investing in low-rated companies with the view that if credit ratings improve, their scrip prices would also go up. Interest rate risk is managed by managing the maturity of the underlying securities, depending on where the fund manager believes interest rates would go.

Hybrid funds

These funds invest in equity and debt markets at the same time. Here, too, risk profiles differ depending on how much they invest in equity markets. Balanced funds typically invest 50-70% in equity markets.

Monthly income plans (MIPs) invest between nil and 20% in equity markets and the rest gets invested in fixed-income markets. Therefore, balanced funds are meant for long-term goals. Whereas, MIPs are more conservative and are used for goals that need to be reached within 5 years with measured risks.

Gold funds

These funds invest in gold. They have passively managed funds and they track the price of gold. Instead of buying physical gold and then having to store it—which will require adequate safety and space—investing in gold funds is a good alternative to buying physical gold.

If you have a demat account, you can invest in a gold exchange-traded fund (ETF), which is a passively managed fund that gets listed on the stock exchanges. Or, if you don’t have a demat account, you can invest in a gold MF scheme, like any other scheme, which then invests your entire sum in a gold ETF.

So which category of mutual fund will suit you

Ascertain your investment time horizon

Ask yourself for how long would you need to stay invested, at the minimum? This depends on how distant is your financial goal. Say, you want to buy a house after 5 years, or you want to send your kids to a good college after 10 years. Or, you want to retire after 20 years and need to build yourself a retirement kitty.

Ascertaining the tenure is important because you need to choose an appropriate fund that matches it. That’s because different MFs cater to different tenures. For example, liquid funds are meant for short-term (parking) needs. Equity funds are meant for long-term goals, but you need to wait out for at least 5 to 7 years, sometimes even longer.

How much should be your emergency fund

How much should be your emergency fund?

An emergency fund is used to efficiently meet anticipated and unanticipated demands for cash distributions. Significant liquidity requirements constrain the ability to bear the risk. Liquidity requirements can arise for any number of reasons but generally fall into one of the following categories:

Ongoing Expenses

The ongoing costs of daily living create a predictable need for cash and constitute one of the investment portfolio’s highest priorities. Because of their high predictability and short time horizon, anticipated expenses must be met using a high degree of liquidity in some portion of the investment portfolio.

Emergency Reserves

As a precaution against unanticipated events such as sudden unemployment or uninsured losses, keeping an emergency reserve is highly advisable. The reserve’s size ranges from three months to more than one year of your anticipated expenses. Individuals working in a cyclical or litigious environment may require a larger reserve than those in more stable settings. Although the timing of emergencies is by definition uncertain, the need for cash when such events do occur is immediate.

Negative Liquidity Events

Liquidity events involve discrete future cash flows or major changes in ongoing expenses. Examples might include a significant charitable gift, anticipated home repairs, or a change in cash needs brought on by retirement. As the time horizon to a major liquidity event decreases, the need for portfolio liquidity rises.

The funds to meet liquidity needs may be invested in either a fixed deposit with one-year maturity or in ultra-short-term bond funds. Both these instruments are taxable, however, an ultra-short-term bond fund will usually earn 1-1.5% more than FD. Additionally, if you continue to hold the ultra-short-term bond fund for over three years, you also get indexation benefit, thereby saving taxes as well.