Mutual fund performance depends on many quantitative and qualitative factors. While returns are obviously the most important metric to consider, relying only on returns does not provide a complete picture of a fund’s risk-adjusted performance or suitability to your needs. Other metrics like volatility, drawdowns, Sharpe ratio and expense ratios are also vital to evaluate the total performance package on offer.
Analyze returns
Returns reflect how much your money has earned in a fund over time. Check annual returns for the longest period available to see average earnings from your investment. For example, an equity fund returning 14% annually over 5 years means Rs. 1 lakh grew to Rs. 1.14 lakh in the first year, Rs. 1.3 lakh in second year and so on. Consistently high returns indicate a superior fund. Also, compare returns with the fund’s benchmark and category to gauge relative performance.
Measure risk-adjusted returns
Returns provide only part of the picture. Check risk-adjusted returns like Sharpe ratio to understand returns generated relative to risks taken. A higher Sharpe ratio indicates higher returns achieved per unit of risk. For example, a fund with 14% annual return and Sharpe ratio of 1.4 has generated higher risk-adjusted returns than a fund with 15% return but Sharpe ratio of 1. Compare Sharpe ratios of different funds to choose one that generates maximum returns for the risk.
Track volatility
Volatility refers to ups and downs in a fund’s NAV reflecting market ups and downs. Less volatile funds, like large-cap funds, experience smaller fluctuations while mid and small-cap funds tend to be more volatile. Check metrics like standard deviation and beta to determine volatility. Standard deviation shows magnitude of NAV variations from the average return. A lower number e.g., 12% indicates less volatility than 20%. Beta measures volatility relative to markets – 2 means the mutual fund gains/losses twice as much as market, 1 means equal to market. Choose funds suiting your risk appetite.
Review maximum drawdown
Maximum drawdown is the maximum drop in NAV from peak to trough during a down market cycle. It reflects losses you may incur if you exit at the bottom. A smaller maximum drawdown such as -25% means lower risk of exiting at a loss verses a fund with -40% drawdown. Study drawdowns of different funds during major market falls like 2008 financial crisis. Funds with smaller, shorter drawdowns limit capital loss risks during volatile periods and recover faster when markets rise again.
Understand expense ratio
Expense ratio is annual fees charged by funds for management and operating expenses. Lower expense ratios indicate less cost to you and more money utilized for actual investments to generate returns. Compare expense ratios of funds within a category to choose below-average fees. However, do not select a fund only due to low fees – other metrics like performance and volatility matter more. Treat expense ratio as a secondary parameter for shortlisting funds but returns and risks come first.
By analyzing these key metrics across funds that you are considering, you can make an informed choice. However, do not depend only on performance data – consider qualitative factors like fund manager background, investment processes and style as well. Look at metrics not just to choose a fund initially but also review regularly to optimize your mutual fund investments for the right balance of risk and return over the long run. Using tools like mutual fund calculators will help ensure that you have a clear understanding of the potential returns and risks involved in investing in mutual funds.
