Mutual funds can be passively or actively managed schemes. Passively managed mutual funds are also known as index funds. They try to replicate the indexes they follow, like the Standard & Poor’s 500 Index. Actively managed mutual funds, on the other hand, try to outperform their indexes by taking on more risk. These funds are run by professional fund managers who may be supported by a research team and a co-manager.
Actively managed mutual funds thus often have a greater potential for high returns. But how do you choose the right scheme for your mutual funds investment? Here’s what you need to keep in mind:
Fund manager: All fund managers have their own investment strategies. How do you select a fund manager that fits your financial requirements? To limit your risk, check up on your shortlisted fund managers first. Examine their qualifications and their track record in the investment markets. If you wish to invest in foreign assets, find out whether the fund manager has an adequate international presence.
Cost of investment: Many fund managers charge high fees for managing mutual funds. This can be a big cost. But you could think of it as an investment in your overall goal of wealth creation. Furthermore, in an actively managed account, the volume of internal processing is high. This is why the cost of investment tends to be relatively higher. To avoid the charges eating into your returns, look for a fund manager who charges a reasonable fee for their services.
Fund history: Just like a fund manager, every mutual fund has a history of its own.Look for schemes that have adjusted to market risks in the past. There are different ways to calculate the risk-adjusted returns for a fund. For instance, you could use tools like the Treynor ratio, Jensen’s alpha, and the Sharpe ratio. Make sure to study the past performance of different schemes before making any mutual funds investment. This will help you to identify the schemes that are consistently good performers.
Diversified portfolio: Fund managers allocate the investment pool of mutual funds to a variety of asset classes. The fund allocation varies depending on the type of mutual fund scheme. As an investor, you should look into the different types of mutual funds and where exactly they reinvest the money. For instance, some big funds may tend to reinvest in similar funds or in companies within the same sector. This reduces diversification of the investment. A diversified portfolio helps to minimize risk by investing across sectors and asset classes. So, if one sector or asset class does badly, the others will prop up the fund to some extent.
Take your time when looking for the right actively managed mutual fund. Remember to verify the fund manager’s credibility and the scheme’s fee structure. Also, keep an eye on the fund’s performance chart and risk-adjusted returns. Once you find the right actively managed scheme, start your investment journey. If you have wealth creation on your mind, explore the equity markets further by opening a demat account with a reputed company like Kotak Securities.