How to Find the Best Mutual Funds

Is there any method to find the best mutual funds to invest? A common question from people especially beginners to the investing. Yes, there is a simple method to find best mutual funds. Follow this article and ask if you have any doubts on anything mentioned in it.

Before investing, ensure your readiness through a self evaluation. click to read the article, “how to become a successful investor“, to get more information on your readiness.

Step 1 – Initial assessment to select and shortlist the funds

Below are some parameters help investors to do an initial assessment and shortlist a group of mutual funds. Utilize the sites such as moneycontrol, valueresearchonline, mutualfundindia etc for the same, if you are in India.

Before starting, ensure using an excel sheet or plain paper to record the below details along with each selected funds. You can shortlist up to 5 to 10 good funds to choose the best funds among them.

1. Type or nature of the fund

There are different types of funds. Some of them are equity, debt, liquid etc. In equity you can find large cap, mid cap, small cap, micro cap, diversified, sector fund etc.. so first identify the fund type. For beginner investors, it is best to choose the large-cap or mid-cap mutual funds at the beginning.

2. Fund rating

Rating of the fund is important. This may change time to time. However, prefer a Crisil 5 or 4 star rated funds.

3. Fund manager performance

Management capacity of the fund manager has a vital role to play. To confirm the fund manager performance, check with other funds managing by the same fund manager. If all the funds are performing well, then you can shortlist the fund.

4. AUM or Asset Under Management

Check the AUM of the fund. It should be considerable high. Funds with little AUM needs to be avoided.

5. Entry and Exit load

Check the entry and exit load and compare the same with similar performing funds. Prefer to invest on a fund that has less or no entry and exit loads.

6. Fund returns in a specified time

Return from the fund is another vital area to look. Check for 3, 5, 10 years returns and compare the return with peers. This will give an idea on how the fund and fund manager is performing. Do not make the mistake of comparing short term such as 3 months or 6 months returns. Mutual fund investments meant for long time. Also check the returns since inception of the fund.

7. Asset allocation

Have a look at the asset allocation of the funds. Ensure the fund has allocated the money propmtly upon the nature of the fund. For example, ensure the major chunk of money allocated to the large-cap stocks only. Record it.

8. Fund comparison with peers

You need to compare all the above points with the peer funds. This will help to identify the best funds from the groups.

Step 2 – Final assessment to select the best mutual fund

Now the time to assess the short listed funds based on the risks, volatility, returns etc. Here some important ratios that would help you to assess the fund.

1. Sharpe ratio

Developed by Nobel laureate William F. Sharpe, Sharpe ratio is one of the most widely used methods for calculating the risk adjusted return of a fund. For example, If a fund taking 10 paise to generate 1 rupee against another fund taking 20 paise to generate 1 rupee, then the first fund is good. Sharpe ratio helps to identify this value.

Highest Sharpe ratio is always the best compare with similar funds. Click to read further here

2. Sortino ratio

Created by Frank A. Sortino, Sortino ratio is a variation of the Sharpe ratio. Sortino ratio helps to identify the volatility of the fund against its bench mark. Through sortino ratio, investors can identify the volatility level of the fund when its benchmark is coming down. This is a good ratio for conservative investors, bothering about the changes in invested capital due to market volatility.

The Sortino ratio is a useful way for investors, analysts, and portfolio managers to evaluate an investment’s return for a given level of bad risk.

Select the funds with higher sortino ratio, means the fund will not go down much than its benchmark during volatility. Click to read further here…

3. Information ratio (IR)

Information ratio (IR) help investors to understand how much the fund beaten the benchmark. It is a measurement of portfolio returns beyond the returns of a benchmark. To find this, get the benchmark return and compare it with the risk adjusted returns from the mutual fund.

The Information Ratio (IR) is often used as a measure of a portfolio manager’s level of skill and ability to generate excess returns relative to a benchmark, but it also attempts to identify the consistency of the performance.

Fund with higher information ratio (IR) result implies a better portfolio manager who’s achieving a higher return in excess of the benchmark, given the risk taken. Aggressive investors can focus on this ratio. Click to read further here..

4. Upside/Downside Captive ratio

Captive ratio help the fund volatility against its benchmark.. Upside/downside captive ratio shows you whether a given fund has outperformed – gained more or lost less than – a broad market benchmark during periods of market strength and weakness, and if so, by how much.

Upside captive ratio for funds are calculated by taking the fund’s monthly return during months when the benchmark had a positive return and dividing it by the benchmark return during the same month. Downside captive ratio are calculated by taking the fund’s monthly return during the periods of negative benchmark performance and dividing it by the benchmark return during the same month.

Final selection of the fund to invest

Now the time to select the good mutual fund to invest. In order to do this, select 3 or 4 funds with higher sharpe ratio. Then check the sortino ratio of these fund and identify which fund has high sortino ratio.

Once done, check the information ratio. Fund with highest information ration is good.

Select a fund with higher sharpe, sortino and information ratio to select and invest.

Where to find these ratios?

Now, you have idea about each ratios and what it is meant to. There is beta ratio too, but no need to add here. It is checking the fund fluctuation against the benchmark and the beta value is more than 1 then the fund can be considered as more volatile.

1. Morningstar India

Visit the morningstar.in site, go to the Tools select Fund performance then type the fund name then select Risk & Rating tab. It will present you with the sharpe and captive (upward/downward) ratio.

2. Rupeevest

Visit the rupeevest.com site and go to the mutual fund screener tool, select the fund, select the column for sortino ratio. You can also find Sharpe, Captive, Beta ratios here. It also provide information about the category rank of the fund as well as total funds in the category.

Additionally, here is a well written mutual fund investment checklist to support you with the above article.

I know all of you are experts. But, in case if you have any doubts on any of the above, please feel free to contact me through putting a comment down.