Mutual fund investment comes in many forms and types, catering to various customers. Mutual fund investing offers some attractive benefits, like the service of a professional asset manager.
Investors trust fund managers to make the right investment decisions to earn profit. It is better to understand how fund managers work if you are an investor.
Here are some common fund management practices that impact your returns.
1. The fund management Fee
The expense ratio or the fund management fee is a standard charge that the fund house collects from investors to cover expenses, like operational costs, salaries, compliance costs, administrative fees, etc. It is usually a percentage of the mutual fund units held by the investor. Most hedge fund companies use the 2/20 model, which allows the company to collect 2% of the fund’s AUM as expense ratio and 20% of the fund’s profit as performance fees.
2. Window dressing illusion
Mutual funds sometimes use a window dressing strategy to make it look like a fund is performing well when it is not. It saves them from explaining the actual reason for poor performance. A potential investor should carefully evaluate the fund’s performance report and general investing strategy before betting money.
3. Indexing strategy to minimise risk
Fund managers are valued for their stock-picking abilities. But many mutual funds now invest in a portfolio close to an index. It helps them generate similar returns and minimise risk. However, this investing strategy may be unsuitable, especially when they charge you a management fee.
4. Focusing on short-term over long-term growth
Sometimes fund managers focus more on the short-term growth of the fund to make it look more attractive to retail investors. This shortsightedness can force the fund manager only to focus on the next quarter’s performance and ignore the broader perspective. As an investor, a fund’s short-term goals may impact your returns and financial goals.
5. Impact of incentives
Mutual fund companies need to bolster their AUM to increase their market presence and profit. To attract new investors, they often resort to advertising and promotion methods. It leaves little time for the fund manager to concentrate on managing the fund. These activities, however, don’t boost the fund’s performance. Retail investors can avoid the effect of the fund manager’s incentive by investing in passively managed index funds.
How to evaluate a mutual fund’s performance
Here are some points that will help evaluate a mutual fund’s performance.
Define investment goals
Before any investment, you should decide the purpose of it. Finding the answer to the question is the foundation of finding the best mutual funds.
Compare peer funds
The best way to find the best mutual funds is to compare a few similar funds for their returns.
Check historical performance data
Although a fund’s past performance is no guarantee of its future returns, these data can help understand how the fund has fared in different market conditions.
Performance compared to index
Fund management fees are payable even if the fund underperformed. So, compare the fund’s costs before you invest. Better funds will typically charge you more.
There is a factor of risk associated with mutual funds. When the fund earns more returns than its inherent risk, we call it risk-adjusted returns.
As an investor, you should know about the common fund management practices for better control over your investment. Now invest in mutual funds with Angel One – open a demat account today!
Disclaimer – This blog is exclusively for educational purposes. The securities quoted are exemplary and are not recommendatory.