"I see that the Kotak Select Focus Fund has an expense ratio of 2.49 which is a bit too high. Also it does not have a 10 year record. Why was this preferred over something like Franklin India Prima Plus Fund or Birla Sun Life Frontline Equity Fund which both have a less expense ratio and a good 10 year track record?"
"I see that Kotak Select Focus has high exposure to banking stocks. Do you believe Banking will do well and therefore recommending Kotak?"
This is an important set of related questions which go to the core of a scientific selection methodology. The explanation below explains our thinking and beliefs.
Choosing "X" fund and not "Y" fund
Let's first recap the selection methodology which we follow at Scripbox:
- Start with the entire universe of mutual funds
- Focus on the growth options only
- Most suitable option from a tax efficiency perspective.
- Eliminate all funds that are relatively small
- Small funds have less flexibility in case of sudden redemption pressure
- Eliminate funds that don't have a track record of at least 4 years
- Proven track record is a necessary criterion for your hard-earned money. A 4-year assessment is in line with global best practices.
- For equity funds for the Long Term Wealth offering, we further select funds that are from the large-cap and diversified (multi-cap) Equity Funds categories
- Themes and sectors require a subjective decision on the prospects of a sector which is best left to experts managing these funds.
- Analyze historical performance for consistency. Our analysis leads us to conclude that consistency reflects a robust underlying investment process and can be counted upon to provide repeatable performance.
(above is a short summary of the detailed note available on our website)
Please note that the expense ratio and portfolio of the fund are not part of the criteria.
Why is "X" fund Chosen?
A fund is chosen because it meets the above rule-based selection criteria. We have arrived at the above selection process through a rigorous evaluation and are confident based not only on historical backtesting but also on the experience in real-time over the past 3 years. We prefer to stick with a tested process of selection, and not make too many changes to a tested algorithm.
There is no single reason for selecting a fund. This is because ours is a top-down approach where the entire universe of funds is concerned, an objective set of rules applied and the selection is an unbiased outcome even if you have never heard of the fund!
Why is "Y" fund Not Chosen?
Similarly, there is no single criterion for not selecting a fund. This is fundamentally different from the bottom-up approach followed by most retail investors where you start with a fund you hear of and compare it to 2 other funds you know of and then decide relative to each other. This is an approach highly influenced by availability bias.
Why are the portfolio/holdings of a fund, not a criterion?
Our belief is that a fund manager with years of experience and access to large research resources is better qualified to make portfolio decisions. It's their full-time job for which we investors pay them a management fee. A fund manager has the freedom to pick the stocks they want and we should select them on the basis of their long-term performance rather than specific portfolio decisions. Note that the fund manager may also change portfolio composition over time.
Why is the Expense Ratio not a criterion?
Expense ratio is not a criterion in our selection methodology because we analyze the fund performance 'after' expenses as reflected in the NAV. As an investor, you are concerned with the return you receive net of expenses. If someone achieves a return of 12 and gives you 10 after charging 2 as an expense, isn't that better than someone who achieves 10 and gives you 9 after charging 1? The only question we should ask is whether that fund manager can achieve that net performance consistently.
Our fund selection is not based on any individual's opinion of a fund's performance, their portfolio or sectoral prospects. It is driven completely by a proven rule-based algorithm which eliminates human behavioural biases for better outcomes.