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Apart from considering the various Qualitative and Quantitative factors, it’s critical to compare the actual performance of a fund vis-a-vis its relative performance against similar funds and alternate investment options. You also need to take a look at the Rolling returns and trading returns of a fund to evaluate its long-term returns, for eg. what are the minimum returns a Multicap fund is providing as compared to its peers in the same category. You’ve got to examine the maximum, median, and average returns of a fund and analyze whether it’s a high risk, low risk, or medium risk fund and not just look at its trailing returns. There are quite a few parameters that can be used to judge whether it’s a wise decision to buy, hold, or exit a fund.

BloombergQuint’s Niraj Shah discusses some common questions on the topic of monitoring a mutual fund with Tarun Birani, Founder & Director at TBNG Capital. Mutual funds have emerged as a popular investment choice among investors who would like to benefit from the expertise of professional fund managers.

However, there are a few pertinent questions that need to be addressed. Is it possible to monitor a fund by simply looking at its NAV? Should it be considered as a long term investment? and how do you decide when to exit a fund? This and much more in the transcript below:

Q: How do you monitor the performance of a fund that you are invested in?

TARUN: While getting into the performance side, the most important part which we have to look into is actual versus relative performance. Let’s say I invested Rs.1,00,000/- three years ago and the value of my investment is now Rs.1,10,000/- only, so in three years my annualized returns are just 3% on an annual basis. This is my actual performance. The relative performance, however, will tell you as compared to the benchmark as to ‘how did I perform?’

That’s one way to look at it and that gives you a picture of the sector or category where you have invested. That’s the way I look at investment returns. The benchmark where you have invested is very critical. I look at another parameter which is called ‘rolling returns’. This gives you a long-term view of that fund on how it is performing with relation to a one, three, or five-year basis. The calendar year return again too is critical. It’s essential and that is one of the huge actual versus relative performance. The investor mostly looks at performance, but we need to get into a relative performance as well and that’s what I look at.

Q: Rolling returns and trailing returns are something that you monitor. How do you monitor these and why did you choose the rolling and training returns parameters?

TARUN: Let me give you a very small example of a rolling return. Let’s take an example of multi-cap funds and say we have four multi-cap funds. While we look at rolling returns, let’s say from a two-year basis for the last 10 years. So, from the last 10 years’ view, the three-year rolling return study will give you a picture of the consistency of this fund. That’s the minimum return which this fund is generating as compared to the category where we have invested. It’s very critical when compared with the category. Once you get there you know what is the minimum that this fund is getting you compared to the category. You then get into the maximum median and into the average part, then you start seeing this fund as to how many times it has given 10, 15, or 20 percent returns. It again talks a lot about consistency, whether it’s a high-risk, low-risk fund, or a medium risk fund. This rolling return study, according to me, is one of the best studies when comparing funds. However, looking only at the trailing return is not a great idea to look at performance.

Q: Is it possible for an average investor to calculate rolling returns or does it come in the fact sheet? How does a person get rolling returns?

TARUN: This data is available on many sites. You will get a rolling return but yes it’s not available on the fact sheet. One needs to really deep dive into getting this data. The second important is the calendar year return and this can save a lot of misery for investors. I look at the last three years’ performance of various benchmarks like NIFTY has given approx 7% returns in the last three years, mid-cap index has given approx 1% returns, banking index has given approx -2% returns.
While it’s very easy to generalize that the mid-cap points have not delivered more than 1% average return, but when you start getting into the calendar year return, then you start observing much more deeply because we had all these SEBI issues with the mid-cap category from 2018-19. Due to that these two years were like a complete washout for the mid-cap category. Starting in 2020, if you start looking at mid-cap funds, you will start realizing that there is a stark change that is coming to the performance. I would suggest looking at the returns more from a calendar year return which is easily available.

Q: What difference would it make if I look at calendar year returns versus maybe a financial year return, the event that we are talking about could have happened in between calendars or in between financial years as well so why choose the calendar year?

TARUN: Calendar year return will check your performance every year. If I look at an X fund and if I look at the calendar year return of that fund. Based on these five years, I am a quartile one, two, or three performers. When you look at point-to-point returns, say if I look at the last six months, I may be a great performer because maybe a very speculative stock like DLF is part of my portfolio. Due to that, I got the performance. But, when I talk about consistency, I want my fund to last for five years, whether there is or there isn’t a quartile two or quartile one kind of performance. The calendar return alone will give you that picture.

Q: How much importance do you give to this monthly monitoring as to what kind of stocks are they buying into? Are they buying some risky names? Should people get into that kind of minute check?

TARUN: One need not get into this process because otherwise, you should get into stock-picking yourself. If you have given your money to someone as senior as a fund manager, I don’t think that is a great idea to get into all that process because then you may get biased and may start taking incorrect decisions This is critical from a setting up investment objective point of view because most people don’t set this up very clearly. They don’t emphasize it clearly and that’s where they get into this monthly monitoring.
They start getting into too much of what is happening every month, in relation to whether this stock is moving or not and which is the highest portfolio holding. I don’t think that’s required. What’s important is whether there is a serious issue in terms of management of that fund. Whether the fund manager changes, all those things are critical, which are very fundamental to the fund. There are basically four P’s on which we look at performance. One is which ‘parent’ that fund house belongs to, the ‘people’, what fund managers part of that, what is the ‘performance’ and then the ‘process’. If these four parts on an overall basis are good, I don’t think one needs to get into all these monthly things regularly.
Additionally, say we are talking about small-cap funds, when you spoke about the monthly monitoring part, something like a category like small-cap fund can be a part of a very tactical portfolio and again timing becomes critical in a category like small-cap funds. If you have started with 100 and your value is already 200, I would definitely look at monthly monitoring of a point like a small-cap fund, which is a very tactical fund in my portfolio.

Q: Assume that my goal is not reached but surely there could be factors which should be taken into account to exit a fund. Even if my goal is not reached, because the theme of the story may have changed, are there things that one should safeguard against or keep in mind?

TARUN: The most important factor we mostly look at apart from reaching the financial goal is the rebalancing factor. As we have clearly defined, while you are doing a suitability exercise, there is a very clear-cut demarcation on the risk tolerance level. Let’s say that if we have defined a 50:50 portfolio for a client and with the rise of the market this 50% becomes 60%. In those cases that 10% rebalancing is something we strongly advocate is to always stay within your means if your defined risk tolerance is 50:50.
That is one very strong reason I would recommend to exit a fund. The second important reason would be the change in the investment strategy of the fund. Let’s say for the last two years, I have been observing many hybrid funds. They have been taking excessive risk and have been taking a lot of credit calls in the debt portfolio. So trust me, when I say I have looked at a hybrid fund, my plain vanilla idea to look at a hybrid fund was that I want somebody who is actively doing that rebalancing 70:30 of the portfolio, but what I observed that 30-35% of the debt portfolio, the fund manager is taking excessive credit risk and that was not my investment objective because I wanted to safeguard my 30-35%. What I would look at is to put that 35% in a pure debt category and 70% into a pure equity category. One very big learning which I had over a period of time is that whenever you see an investment strategy change, like last week we have observed SEBIs diktat that they will change the structure of mid, small, and large-cap. I think one needs to get very serious about it because the mid-cap and the small-cap proportion of the portfolio will dramatically change with this change in the multi-cap category. If something like this happens, then we need to look at the overall risk profile.

Q: In the first answer you mentioned how you would also look at a fund manager exit, as a sign of whether or not to stay in a fund or get out and why would you do that?

TARUN: A leader of your organization is always a very critical factor while getting into anything you start with. Let’s say I talk about a small in a mid-cap category, it is very critical, because the investment style of the fund manager is something which helps you generate that extra alpha and when you see the exit of that fund manager happening, it becomes a very serious issue because you need to be careful that the kind of alpha with which expectation you are coming to that might not hold true, for another guy coming in that may completely change for you. That is where you need to be very careful about it.