If you’ve been shopping around for mutual funds in the Indian financial market, you may have no doubt taken a closer look at the returns that the funds offer. If you pay attention, you’ll notice that the mutual fund returns for two different schemes are different. What’s more, even the returns from the same mutual fund differs from one year to the next. 

So, why is it that the performance of mutual funds varies year on year? And why are the mutual fund returns for different schemes different, even if they invest in similar assets? The answer lies in the fact that there are many factors that affect the performance of a mutual fund. 

In this chapter, we’ll take a closer look at the factors that affect mutual fund returns. Let’s get started. 

The expense ratio

The expense ratio tells you about the proportion of the fund’s assets that are used to manage and administer the fund on a regular basis. Every mutual fund scheme levies these charges. They help provide funds to meet the marketing costs, the cost of the back-office admin work, the clerical charges and even the fees payable to fund managers. Your returns from a mutual fund scheme will be the investment gains, reduced by the management fees and costs. 

So, as you can see, the expense rate reduces the amount of assets that the fund has in its portfolio. And consequently, it can reduce the returns that you receive from your investments in the mutual fund. Typically, the expense ratio of most funds is around 1% to 2% of the total assets available under the mutual fund scheme. It goes without saying that the higher the expense ratio is, the more your returns would be reduced. 

The size of the fund

The size of the fund or the Assets Under Management (AUM) gives you a fair idea of how large the fund is. In other words, it refers to the total market value of all the assets in the mutual fund’s portfolio. The AUM may not directly influence the returns, but it can influence how the capital is managed by the fund manager. 

As one study showed, increasing AUM may increase the mutual fund returns up to a certain point, since the fund manager has more money to invest in the markets. However, after a certain point, the returns may start to decline because it gets more difficult for the fund manager to find optimal investment opportunities for the increasing inflow of capital. That said, different mutual fund schemes may react differently to the changes in their AUM.

The fund manager’s expertise

This is a factor that directly affects the mutual fund performance. Fund managers play a key role in deciding how the money pooled together by investors is invested in the markets. They determine the assets in which the fund invests as well as the proportion of capital distributed to the chosen assets. In addition to this, fund managers are also responsible for monitoring the performance of the fund and deciding when or if any changes in the asset allocation is required.

This is why it is always important to check out the expertise of the fund manager before you decide to invest in a particular mutual fund scheme. A fund manager with the right management skills can ensure that the scheme delivers optimal returns, subject to market conditions, of course. 

The assets in the fund portfolio 

The assets that a fund invests in also directly influence the returns from a mutual fund scheme. Typically, schemes that invest in safer options like debt instruments and money market securities tend to offer stabler returns, although the returns may be lower than what other risky investments like equity offer. 

However, equity funds are generally better at delivering good returns over the long term, since market volatility tends to bring down the returns over the short term. To understand how a mutual fund will perform, it is always a good idea to take a look at the asset portfolio of the fund and ensure that it is aligned with your investment goals. 

Macroeconomic factors 

Aside from the fund-specific factors discussed above, there are several macroeconomic forces at play that can influence and affect the mutual fund returns. This includes the general inflows and outflows of the mutual fund scheme, the inflation in the economy, and the GDP. Additionally, the changes in the financial markets and the overall market movement also impact the performance of mutual funds.

Any material changes in the sectors and industries that the fund invests in also impact the returns that your investments will generate. So will any governmental policies that directly or indirectly impact the economic sectors associated with the fund.

Wrapping up

As you can see from the factors outlined above, the metrics that influence the performance of mutual funds include factors specific to the fund as well as generic aspects like macroeconomic forces. It is certainly not possible for an investor to factor in all of these details before making an investment decision. However, you can certainly ensure that the fund you invest in is aligned with your investment goals and has a good track record. In the next chapter, we’ll get into the details of how you can calculate the returns from your mutual fund investments. 

A quick recap

• The expense ratio tells you about the proportion of the fund’s assets that are used to manage and administer the fund on a regular basis. The higher the expense ratio is, the more your returns would be reduced. 
• The size of the fund or the Assets Under Management (AUM) refers to the total market value of all the assets in the mutual fund’s portfolio. The AUM can influence how the capital is managed by the fund manager. 
• The fund manager’s expertise is a factor that directly affects the mutual fund performance. This is why it is always important to check out the expertise of the fund manager before you decide to invest in a particular mutual fund scheme. 
• The assets in the fund portfolio and other macroeconomic factors also impact fund performance.