Ever since
SEBI introduced direct plans for open ended mutual funds in 2013-14 (Read more
about Direct plans below (1)), I have observed that many of my friends have
started unsupervised equity mutual funds investment (both lumpsum and SIP
route) themselves.
For them to
reaffirm their convictions and for those who want to learn, I am listing down
few criteria for shortlisting equity mutual funds. As an example, I am using
the Fund Factsheet for AUG 2018 of the Parag Parikh Long Term Equity Fund
(PPFAS) to illustrate my findings.
1 The planned holding period in the
said mutual fund –
As a thumb rule, people should only consider investing in equity if the
holding period is at least 5 years (ideally it is 11 years since that is the
time required for a complete business cycle). This is applicable for both
lumpsum and investment through the equity SIP route. If you have a shorter planned
holding period, you should consider Fixed Deposits in government banks or Liquid Mutual Funds. Mutual
funds usually have exit load to encourage people to invest for longer terms.
For example, in case of PPFAS, they have put an exit/redemption load to
encourage people to be invested in their fund for at least 730 days. If you
redeem 100 Rs out of your investment before 365 days, you will essentially get
98 Rs.
Validate the fund objective vis-Ã -vis the
constituent of that mutual fund –
Suppose a mutual fund is called ‘XYZ emerging Bluechip fund’, now the
first step is to look at the holdings of this mutual fund. Suppose you see that
it has invested in Reliance (say 9%), HDFC (say 9%), ITC (say 7%). So, a good
25% of the fund’s asset are already in well established Bluechip companies and
hence it is improper to qualify it as an ‘Emerging Bluechip Fund’.
Basically, whenever and where ever you see that the constituent of the
funds is not aligned to the fund objective, please avoid that fund. For
example, in case of PPFAS, the fund objective is as stated below
The fund holdings are mentioned below.
You can see
that PPFAS does stick to it’s fund objective very clearly through this
portfolio allocation.
3 Constituent of the fund vis-Ã -vis Nifty
stocks
Many of the so called ‘actively managed funds’ (charging quite high
expense fees) do not add much expertise in fund management. They would rather
majorly mimic the Index (Nifty/Sensex). If you plan to put money in any fund
which has more than 40-50% of it’s asset put in NIFTY stocks, would not it be
prudent to rather put your money in an Index Fund and save on the expense fees. Also, the given fund should be protected against Index Draw-down. That adequately demonstrates the fund allocation skills of the fund manager. You can see the comparison of the PPFAS with an Index fund over a considerable long period.
As in case of PPFAS, this is 20% (Approximately) of its total asset. Below is
the break up.
Bajaj Investments -
5.88%
HDFC Bank -
5.63%
ICICI Bank -
2.61%
Axis Bank -
2.43%
Sun Pharma -
1.58%
Dr.Reddy -
1.57%
Total = 20% (Approximately)
I have not included the special situation/Arbitrage holdings because
they are already hedged.
4 Fund Size (Asset Under Management)
It is not mandatory to report the capacity of the mutual fund as per
Indian laws but it is an extremely important parameter to look at. Capacity of
a fund is defined as the amount of money the fund can handle easily without
deviating from the fund objective.
As a thumb rule, if a fund has a huge asset under management you should
be cautious investing in it since the fund manager may not find so many opportunities
to deploy such huge capital and which in turn can affect performance. Lately, I
have seen one fund managed by Mirae Asset management stopping lump sum
investment since it was finding it difficult to deploy funds. Further reading (2).
In case of PPFAS, the fund size is 1352 INR crore. During my interaction
with Parag Parikh Sir in one of the investors meets at the early days of PPFAS,
he had mentioned that the capacity of this fund is around 3500 INR crore. So as
of now it is quite fine. Need to revisit this once the AUM grows closer to the
3500 INR crore figure.
5 Fund Manager Attrition
Look for fund schemes where there are not many instances of Fund Manager
attrition. Every manager had his own distinct style and his own way of achieving
the fund objective. Whenever there is frequent fund manager transition, the
performance of the fund suffers. Ideally, the fund manager should be associated
with the fund since inception of the fund, however, if that is not the case,
association of 3 years or more can be a good thumb rule.
In case of PPFAS, you can see that both Raunak and Rajeev are there since
almost the inception of this fund.
6
Portfolio Turnover Ratio
This is a very important number to look at while selecting any equity
mutual fund. The portfolio turnover ratio shows the amount of churning in the
portfolio of the mutual fund. So, a low portfolio turnover ratio essentially
means that the fund manager has a long term vision and is convinced about
holding the stock even amidst short term volatility. If a fund has an
exceptionally high Portfolio Turnover Ratio, however you notice that the fund’s
portfolio has not changed much over a given period, there are chances that the mutual
fund is involved in selling and purchasing the same stock in equal numbers to
maintain the percentage allocation same but generating trading expense to
support in house brokerage houses. I have observed this pattern in few of those mutual
fund houses who has brokerage business too.
In case of PPFAS, the annualised figure is very low.
7 5 Years performance
The only performance which matters for a mutual fund is 5 years or more
performance (since that is what the recommended holding period is). Performance
for 5 years or more tells you exactly how the fund has performed over
considerable business cycles.
In case of PPFAS, the annualized return for monthly SIP is 17.91% whereas
the Nifty 50 has returned 15.43%
8 Total Expense Ratio(TER)
The total expense ratio (TER) is a measure of the total cost of a fund
to the investor. Total costs may include various fees (purchase, redemption,
auditing) and other expenses. The TER calculated by dividing the total annual
cost by the fund's total assets averaged over that year, is denoted as a
percentage. The lesser the TER, the better. Since that means more of your
investment will be put to market.
In case of PPFAS, the TER is as below
9 Check the overlap of your existing fund’s
holdings with the holding of this new fund. If there is an overlap of more than
40%, you need to choose between either of the 2 funds (depending on which fund
is better based on the criteria already defined)
Social Media endorsement of the Fund Manager - Check how the comments and thoughts of the fund manager/CIO of the respective fund houses garner traction in social media platform like 'X' . That gives a fair idea of the thought process of the various fund house.
I look
forward to your comments and may update this document if I feel I have
something superior to add. My twitter ID -
@Booombaastic
References
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Hallmark of a Great Mutual Fund House !!
In
this note, I would mention the features that make a very good equity
mutual fund. Below mentioned are some important factors that your Equity
Mutual Fund should have in case you intend to invest in it:
1. Keeps Costs Low:
Mutual
Funds are termed costly, which have higher expense ratios, low cost
funds have lower expense ratios. Therefore to have a mutual fund with
higher expense ratio will make less sense, because a large share of
investor's hard earned money that he has parked to earn maximum returns,
is consumed by the AMCs as a part of their fees. The expense incurred
by the AMC / fund house determines the amount that gets invested. A
low-cost mutual fund scheme charges low Total Expense Ratio (TER) for
investing in their fund.
2. Be Transparent:
In
today's world it is very important to maintain a good relationship with
the customers, and to maintain a good relationship, there has to be a
level of transparency. This holds true even for mutual funds, while all
mutual funds disclose the stocks they buy through factsheets, not many
disclose the amount of commission paid to Mutual Fund distributors.
It makes sense not to invest in a typical high-cost mutual fund that consciously uses distributors and big ads to attract your money!
3. Keeps Products Simple:
Rather
than cluttering the investor's basket with all look-a-like products,
that are only meant to confuse investors, a great mutual fund house
believes it is better to offer few selective products that will answer
our investor's investment needs. They behave as Asset Creators and not
Asset Collectors.
4. Adopts a Prudent Approach:
AMC
needs to follow prudent investment practices that nurture trust and
confidence of its investors in them. Mis-selling of products should be
avoided and the focus should be on customer satisfaction rather than
profits. While some AMC's are slightly conservative, others go all out
in the pursuit of high returns, which either may or may not pay off in
the long run.
5. No Mis-selling, under any circumstances:
Mis-selling
of products is one of the most common problems faced by the investors
today. The industry is cluttered with look-alike products that are
disguised with benefits. Mutual Funds are nothing but a pool of
investors hard earned money invested in scheme that aims to grow and
bring good returns. While SEBI has taken constructive steps to address
this issue, it is AMCs responsibility to abide by the ethical practices
and prevent mis-selling of its products.
6. Skin in the game:
The
mutual fund AMC where the fund manager, trustee and other important
people have substantial investment in their own funds. That ways you
ensure they have skin in the game and are accountable for their work.
Moreover,
it is important to follow these fundamental practices and imbibe these
ethics to build India's premier investment management company by
offering our clients a disciplined research and investment process to
take advantage of the long-term investment opportunities that exist
across various asset classes - while balancing the inherent risks of
investing in an evolving market.
PS: Compiled from my understanding of the various articles on this topic.
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