How to Analyse Mutual Funds’ Performance
The market presently boasts of a number of viable mutual funds as well as fund managers that have proved themselves over the short-term as well as the long-term. On occasion, stellar performance can be owed to a mutual fund manager’s ability to select stock and/ or make appropriate asset allocation decisions. Continue reading to understand how to analyze a mutual fund’s portfolio to determine whether it is capable of accruing big returns.
Analyzing a Given Mutual Fund’s Portfolio
Regardless of the mutual fund under consideration, there exists an outlined investment mandate that makes clear what exactly the given mutual fund will invest in. This outlined mandate could propose investments in large or small companies and will state whether said companies boast of value or growth characteristics. The mutual fund manager is expected to abide by the proposed investment objective. While a mutual fund’s specific investment mandate is important as it reveals key details of its investment objectives, there are other parameters that must be considered as well.
Fund managers may on occasion choose to gravitate towards certain sectors. This may stem from their having greater experience within said sectors or else due to the fact that the characteristics they seek within companies compel them to direct their attention towards certain industries. In the event that a fund manager relies upon a certain sector alone, they could limit the possibilities available to them if they haven’t widened their investments.
In order to determine what a fund’s sector weight amounts to you must either employ the aid of analytical software or else use sources like MSN. As an investor, you must draw comparisons between the mutual fund of your choice and the appropriate indexes in order to understand where the fund’s manager enhanced or reduced their allocation to certain sectors relative to the index. By performing this analysis, you will be able to comprehend whether the manager has over or underexposed the portfolio to specific indexes and will be able to understand what the fund manager’s tendencies are along with what the performance drivers are.
This analysis requires you to simply list down the fund and relevant indexes adjacent to one another with a breakdown according to their sectors. Take for instance, for a large-cap manager, the easiest way to understand sector reliance would be by placing the fund’s sector breakdown next to the S&P500/Citigroup Value Index and the S&P 5000/Citigroup Growth Index. Each of these indexes displays unique sector breakdowns as it’s quite common for certain sectors to frequently fall under the growth category while others get grouped under the value category. Take for instance industrials that fall under the value sector are likely to have greater weightage within the S&P 500/Citigroup Value Index as opposed to the S&P 500/ Citigroup Growth index. This falls in contrast to technology which is qualified as a growth sector and is more likely to dominate the S&P 500/ Citigroup Growth Index rather than the S&P 500/ Citigroup Value Index. Comparing the fund relative to its sector breakdown keeping in mind these two indexes will help reveal whether the fund is operating in accordance with its stated mandate. It will also make clear whether there exist any over or under allocations relating to a certain sector.
Analyze a Fund’s Attributes
Fund managers may choose to select stocks using a top-down approach or a bottom-up approach. The former sees the fund manager evaluating the economic environment in order to zoom in on global trends such that he (or she) can understand what sectors or regions will benefit from such trends. In contrast, the bottom-up approach doesn’t consider macroeconomic factors when determining what companies it ought to invest in. Instead, the fund manager will utilize certain criteria ranging from growth and size to earnings and valuation in order to sift through companies. Due diligence is then performed on the companies that are able to move forward after each stage of sifting.
In order to understand whether a fund manager is actually enhancing the value of a fund’s performance keeping in mind his stock-picking or asset allocation, you as an investor must carry out an attribution analysis. This will help shed light on a fund’s performance keeping in mind its asset allocation set against its performance owing to stock selection.
If you are still wondering how to do mutual fund analysis, such that you can enhance your holdings, use the suggestions listed below.
Ascertain What the Economic Cycle Is
Time periods serve as a great tool that can be used to understand what funds perform well. One bad year shouldn’t be a reason alone to dismiss the fund from your investment portfolio.
Take Stock of 5- & 10-Year Milestones of a Fund
Trends and styles employed for fund management keep altering as do mutual fund recommendations. Owing to this very fact it is important to assess a mutual fund’s performance over different economic environments such that you can accurately ascertain which funds have stood the test of time. A full economic cycle lasts 5 to 7 years and is characterized by growth as well as recessionary periods.
Measure the Performance of a Fund
As an investor, you are often able to see the performance of a given mutual fund keeping in mind 1-year, 3-year, 5-year, and 10-year returns. If you must assign weightage to mutual funds in order to which you must give the most emphasis to the 5-year investment would be in the lead, followed by the 10-year, 3-year, and 1-year. Provided you multiply the percentage weights of the funds by their subsequent returns for the outlined time frames and average their totals, you will be able to compare funds with ease.
In order to understand how to analyze the best mutual fund, you can employ a wide range of measures some of which have been touched upon in this article. Additionally, you have the option to compare funds across a number of parameters ranging from fund history and fund expense ratio to risk-adjusted returns and average maturity and duration. Comparing the alpha and beta of a fund along with its portfolio turnover ratio can also provide insights into which fund will provide you with larger returns. Always read the fine print prior to investing in a given mutual fund and don’t ever overextend yourself.