Investors need to exercise as much care choosing mutual funds as they do when it comes to selecting stocks.
Since equity investing is for the long term, let’s take a closer look at the return profiles of the best and the worst performing equity mutual funds over the past 20 years. While the best-performing scheme, HDFC Taxsaver, generated an annualised return of 28.77%, the worst performing scheme, LIC MF Equity, returned just 8.29%.
To put this into perspective: Rs 1 lakh invested in the LIC MF Equity, for 20 years, would have become Rs 4.92 lakh, but the same invested in the HDFC Taxsaver would have become Rs 1.57 crore. This shows how critical it is to pick the right funds to build a decent-sized corpus.
Given that the mutual fund industry was opened up for public sector entities in 1987 and for private sector entities in 1993, the increased competition may not allow for such massive performance gap among funds in the next 20 years. The Indian capital market has also matured in the past two decades. However, the importance of picking the right funds cannot be overstated.
The best long-term performers
The top five mutual funds have generated an average return of 26% over the past 20 years.
The worst long-term performers
Funds with smaller AUM size, which indicates lack of investor interest, often lag peers
NAVs and CAGR return as on 23 June 2017, AUM is as on 31 May 2017. Source: Value Research
Long- term performance
Though past performance is not an indication of a how a scheme will fare in the future, historical return analysis can throw up interesting points. As a first step, investors can concentrate on schemes that have been around for a longer time and avoid schemes that haven’t seen a bear market. This is because a bear market is the real test for a fund manager. “Go for funds that have performed well across market cycles and concentrate on funds that outperformed peers when the market was not doing well,” says Vikash Agarwal, Co-founder, CAGRfunds.
Ascertain fundhouses’ research capabilities. While it is easy to identify research capabilities of established fund houses like Reliance, HDFC or ICICI, how should one analyse the research capabilities of new fund houses? In such cases, the pedigree of the fund house or its promoter should be taken into consideration. “Investors need to give extra weight to mutual funds coming from groups like Motilal Oswal, which have demonstrated their research capability over several decades,” says Agarwal of CAGRFunds.
There are several reasons for sticking with large fund houses or schemes. First, it is difficult for the smaller fund houses to match the size of research teams maintained by big fund houses. Stability of fund managers is also an issue with most small fund houses. Accesses to external research can also become problematic for smaller funds because sell side research teams usually offer better service to larger funds—from which they draw higher business.
“Corporate access is also difficult for smaller funds. Smaller fund houses have also been seen to take undue risk to shore up their short-term performance,” says Abhimanyu Sofat, VP Research, IIFL. Even large fund houses ignore their very small schemes and often merge them into a larger, better-performing schemes. Hence, it is best to avoid very small schemes from even the bigger fund houses.
Investors need to make sure that the fund house and or scheme follows a clear strategy across market cycles. “Continuity in strategy is key,” says Agarwal. You also need to ascertain whether the investing style of a fund house is in sync with your risk appetite. “While Reliance mutual fund follows an aggressive style, HDFC and ICICI follow counter cyclical styles,” says Sofat. Continuation of the fund manager is also critical for the continuation of the investment strategy. “IDFC Premier Equity was a best performing scheme when Kenneth Andrade was there, but now it has started underperforming,” says Agarwal.
Fund manager investments
It is better if investors go for schemes where the fund manager has invested his money into it. “CIOs or fund managers investing in their own funds show that their personal wealth creation is also aligned with their fund’s performance,” says Sofat. However, this rule works only when it is voluntary and not forced upon the manager— like the recent rule made by Kotak mutual fund making it mandatory for the manager to invest in his own funds.