How to Analyse Mutual Funds?

Mutual funds have become a popular way to grow wealth over the long term. They offer diversification, professional management, and a wide range of options that suit different goals. But if your focus is on how to analyse mutual funds for returns, you need to go beyond surface-level details like past performance or brand reputation. A proper analysis involves looking at fund categories, risk factors, costs, portfolio quality, and consistency.

This guide explains the main aspects to consider when evaluating mutual funds so you can make informed investment decisions.

Key Takeaways

• Start by aligning the mutual fund choice with your financial goals and risk appetite.
• Compare the fund’s returns with its benchmark index to judge performance.
• Look for consistency across 1-year, 3-year, 5-year, and 10-year periods.
• Evaluate risk metrics like beta, Sharpe ratio, and standard deviation.

Step 1: Understand Your Financial Goals

Before you begin analysing, start with your own objectives. Ask yourself:

• Am I investing for short-term needs or long-term wealth creation?
• Do I want capital appreciation, steady income, or a mix of both?
• What is my risk appetite, low, medium, or high?

Mutual funds are designed for different needs. For example, equity funds are better suited for long-term growth, while debt funds are often preferred for stability.

Step 2: Check the Fund’s Category and Benchmark

Every mutual fund belongs to a category, equity, debt, hybrid, or thematic. Within equity funds, you’ll find large-cap, mid-cap, small-cap, and sectoral funds.

To know whether a fund is performing well, compare it with its benchmark index. For instance, a large-cap fund is usually benchmarked against the Nifty 100 or BSE 100. If the fund consistently beats its benchmark over different periods, it shows the fund manager’s ability to deliver returns.

Step 3: Look at Past Performance

Although past returns do not guarantee the future, they provide insights into how the fund has performed across market cycles. When you analyse:

• Compare 1-year, 3-year, 5-year and 10-year returns.
• Check performance in both bullish and bearish markets.
• Look for consistency rather than sudden spikes in returns.

A fund that has steadily outperformed peers and benchmarks over long periods is usually more reliable.

Step 4: Evaluate the Risk Profile

Returns often come with risks. To judge the risk level of a mutual fund, you should consider:

• Standard deviation – measures how much the returns fluctuate.
• Beta – shows the fund’s sensitivity to market movements.
• Sharpe ratio – indicates whether the returns justify the risk taken.

For high returns, you may need to accept more risk, especially in mid-cap and small-cap funds. But balance is important, excessive risk can lead to steep losses.

Step 5: Analyse the Expense Ratio and Exit Load

Costs eat into your investment returns. Two key charges to check are:

• Expense ratio: The annual fee charged by the fund for managing your money. Lower ratios are generally better.
• Exit load: A fee you may pay if you redeem units before a set time.

Even a 1% difference in expenses can impact your long-term gains significantly, especially when investing large sums.

Step 6: Examine the Portfolio Holdings

Looking inside the fund’s portfolio gives you a clear picture of how it generates returns. You should check:

• The sectors and industries where the fund invests.
• The concentration of top holdings. A fund over-reliant on a few stocks may be riskier.
• The balance between large-cap, mid-cap and small-cap companies.

For debt funds, look at the credit quality of bonds. Higher-rated securities (AAA, AA) are safer but may offer lower returns.

Step 7: Review the Fund Manager’s Track Record

A mutual fund’s success depends heavily on the expertise of its fund manager. Investigate:

• The manager’s experience and time spent with the fund.
• Performance of other funds managed by them.
• Their ability to navigate both rising and falling markets.

A seasoned fund manager who has consistently delivered results adds confidence to your investment.

Step 8: Assess Fund Size and Liquidity

Fund size also matters. Extremely large funds may face challenges in delivering high returns because spreading investments across many companies becomes difficult. On the other hand, very small funds may lack diversification.

Liquidity is equally important. Open-ended funds allow you to buy and sell units easily, while close-ended funds lock in your investment for a fixed period.

Step 9: Tax Efficiency

Returns should always be considered alongside taxation. In India:

• Equity mutual funds held for more than one year are taxed at 10% for gains above ₹1 lakh (long-term capital gains tax).
• Debt mutual funds (after April 2023) are taxed as per your income slab without indexation benefits.

Choosing the right type of fund can help you optimise post-tax returns.

Step 10: Align with Market Conditions

Market trends affect fund performance. For example:

• During strong equity markets, growth-oriented funds usually perform well.
• In volatile times, balanced or hybrid funds can provide stability.
• When interest rates rise, debt fund returns may decline.

Analysing mutual funds in the context of economic and market conditions helps you stay realistic about return expectations.

Conclusion

If you want to know how to analyse mutual funds for returns, you need a structured approach. Start by aligning the fund with your goals, then examine its category, performance, risk, costs, holdings, and the fund manager’s track record. Remember, returns are not just about chasing the highest past performance but about choosing funds that balance risk and reward over the long term.

By carefully evaluating these factors, Indian investors can increase their chances of building wealth through mutual funds while staying aligned with their financial objectives.

FAQs