Viewpoint : Selecting Mutual Funds

I have often wondered if it makes sense selecting mutual funds for investment. Once you have marked your top 10 funds for investment based on ethics, values and actions, there is little difference between them. Have you ever wondered why a fund rated five-star a few months back doesn't even feature in the top 20 list today? Let me explain with an example.

Lets say, you bought Reliance during the month of Jan '00 with a 3-year view. For the period, you would have seen returns of 15-20% on the stock. If you extended your time frame by a few more years, you would have seen a compounded return of over 100% atleast! It is almost impossible to give a time-frame and a ranking of stocks which would give you an assured return within the expected time-frame! In the same way, it is impossible to predict if a fund would outperform within the time span of 3 years.

What one needs to view is the strategic fit of the fund in ones portfolio. Choose the best managed funds based on ethics, best practices(timely portfolio disclosures, transparency etc) and most importantly the funds(or fund managers) actions. If you aren't comfortable holding a fund with high PE multiple, portfolio structure or high equity allocation, you should refrain from investing in such a fund.

While one can rank funds in order of returns on a daily basis, note that the returns are not an indicative of future performance(the tag line at the end of every mutual fund advertisement has a deeper meaning!). While HDFC Tax saver doesnt feature in top 5 based on returns over a 3-year frame, it cant be written off as a non-performer. No rating can explicitly guarantee a funds future performance. The only guarantee is your comfort level based on the factors discussed above. For instance, I wouldn't like to invest in funds which make delayed portfolio disclosures and where I have little clarity on the fund managers actions. At the current stage, I would be comfortable investing in funds with greater cash/debt exposure as I believe this would be the best strategy for long term outperformance. Henceforth, it makes sense to select funds based on base parameters discussed above. However, to say, that one fund is better than the other or rate it in some way has no meaning!

One needs to hold patiently till the fund reaches an optimum sell value. If you have fixed your time frame, then your investment may not yield best benefits. For instance, while "ABC" fund may yield 100% returns over a period of x years, "XYZ" fund may yield the same returns over a different time frame. The compounded annual returns for both funds would be the same or marginally different, it is only the holding time-frame which varies.

In my previous articles, I have recommended funds based on my comfort level(looking at economic indicators and the fund managers actions) and hence does not say anything about the future performance of other funds which were not analysed. "Keep the return constant, not the holding time-frame for the chosen fund".