Analyzing Mutual Fund Schemes to Select the Best


So, after an entire month of taking a break from blogging (not from learning finance though) and some time spent in shifting to a new place, I wondered on which topic I should write now. Yes, there are lots. Much to learn, and to share. So in this post, I’ll share what I learned last month. For a long time, I was planning to invest in a mutual fund. Is it risky? Yes. Then why? Coz, I’m only 24. I can afford to make mistakes. But this doesn’t imply that I’m taking a random decision without proper research. I have learnt the basics, the types, the influencing factors, and the pros and cons. With time by my side, I intend to use this age to learn as much as possible through books, the internet, and personal experience. So, I dedicated some days to analyze and select a mutual fund scheme that will help me achieve my financial goals in the long term. During the analysis process, I came across many parameters, ratios that one should use to compare a fund scheme with the other. These parameters and ratios help one to select the most appropriate fund scheme. Let’s know them…

I first decided on the category of funds in which I want to invest. Then, I prepared a list of funds belonging to that category. Then I filtered the best ones based on the below parameters and ratios:

  1. Absolute Returns: Returns are the most crucial parameter that one uses to judge a mutual fund scheme for obvious reasons. I captured the returns of the schemes I had chosen, under four heads: 1-year returns, 3-year returns, 5-year returns, and 10-year returns. This helped in comparing the schemes and sorting them on the basis of the long-term returns. One should also compare the returns of the scheme and the benchmark of the scheme. The scheme should outperform the benchmark. One should also compare the performance of funds having the same benchmark. This will help is selecting the best in the category.
  2. Years of Existence: Years of existence play an important role in the selection process. One should go for a fund which has a proven track record. A fund which has been in existence for a long time say 5 – 10 years has a track record of its performance under both up and down cycles, which helps us to judge it better.
  3. Expense Ratio (MER): It is the total percentage of fund assets that is being charged to cover fund expenses. One should always pay much importance to this parameter as it impacts the returns. A large expense ratio can eat away your returns, resulting in a sub-par performance. Thus, it is advisable to go for the fund with very low MER.
  4. Entry and Exit Loads: Entry load is the charge that is incurred by the investor for investing in a fund scheme. Exit load is the charge an investor bears for exiting a fund scheme (exiting can be switching to direct from a regular plan and vice versa or closing the investment altogether). One should always try to go for funds which don’t have any entry and exit load.
  5. Asset under Management (AUM): The comfortable size in equity is hundreds of crores (1 Crore = 10 Million) and for debt it should be thousands of crores. The fund scheme should have a considerable asset under management (AUM). Less AUM in any scheme is very risky as the exit of any big investor can adversely impact the overall performance of the mutual fund scheme. Also, too big of AUM can also affect the performance of the scheme as it makes difficult to acquire and dispose stocks without impacting them dramatically in their price.
  6. Standard Deviation: This is a measure of the volatility of a fund’s returns and, therefore, indicates the risk in a fund’s portfolio. Steps to calculate it are as follows:
    1. Calculate the average of daily returns.
    2. Deduct this average from each daily return and square the difference.
    3. Divide the sum of all these squared values by the number of days to get the variance.
    4. The square root of the variance is the standard deviation.

Lower the deviation, the better it is. However, one needs to compare it only within categories. The range can be below 1% for liquid funds and 20%-40% for equity funds.

  1. Sharpe Ratio: It is used to calculate the risk-adjusted return, i.e. the return per unit of the total risk taken by the scheme. It is calculated as (Return – Risk Free Return)/Standard Deviation.

One should note that this ratio should be used to compare only within categories. Higher than category average Sharpe ratio indicates that the fund manager was able to generate higher returns per unit of total risk.

  1. Beta: It measures the fund’s performance compared to the market. Steps to calculate Beta are as follows:
    1. The variance of market index is calculated as explained for Standard Deviation.
    2. To calculate co-variance between market index and the scheme, the difference between daily returns of the scheme and the index is first squared.
    3. The sum of all these squared values is divided by the number of days to get the covariance.
    4. Finally, beta is calculated by dividing the covariance between market index and the scheme with the variance of the market index.

A beta value of one means the fund’s NAV moves with the market. Less than one means the fund is less volatile than the market, and above one indicates it is more volatile than the market.

  1. Portfolio Turnover Ratio: This indicates which is how long the manager keeps the stocks in the scheme’s portfolio. If the manager buys and sells stocks frequently, the expenses are going to be higher.

Do note that, this ratio needs to be compared within the category. Active investors can opt for schemes with a high turnover ratio, while passive, long-term buy and hold investors can go for low turnover ratio schemes.

It is calculated as follows:

{Total Value of New Securities bought or the Total Value of securities sold (whichever is less) over 12 months period} / Total NAV

  1. Portfolio Concentration Ratio: This is usually a percentage of the fund’s top five stocks or sectors. I took top 10 stocks for my analysis. This indicates where and how much the fund has invested. Normal range for the top stocks is 30%-40% and for the top sectors is 30%-60%. Any excess concentration of a single stock or sector in the portfolio defeats the diversification goal of mutual funds.
  2. Alpha: Often being called as the active return on investment, alpha is the excess return of a fund relative to the benchmark index’s return. It is an indicator of the value addition by the fund manager. Alpha>0 indicates that the fund manager was able to add value to the portfolio and thus the fund has outperformed the benchmark index.  Alpha<0 indicates that the fund has under-performed the benchmark index. An alpha of 0 indicates that the fund is perfectly tracking the benchmark.

Note: The parameters and ratios explained above are used in analysing equity-based funds. Debt funds analysis also uses these parameters and some more.

Here is a snapshot of how I did my analysis:


Analyzing different schemes is a bit tedious, but definitely rewarding. I did all my analysis using Excel spreadsheet. But, one can also find these insights online. Morningstar, Value Research Online are good portals providing valuable insights into the mutual funds. They also publish the list of top funds across various categories. So, it becomes easier for the investor to select the best fund for himself. Having said that, the importance of learning how to analyze a fund scheme cannot be undermined. Knowing what the parameters and ratios are, how they are calculated, and their implications, definitely helps in taking a sound investment decision.

“Know what you own, and know why you own it.” – Peter Lynch



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