In today’s world, there are many different ways to invest your money. These include FDs, stocks, bonds, and mutual funds. Mutual funds are a popular choice of investment, providing exposure to a basket of securities at low investment amounts. There are many financial ratios that can help you measure how well a mutual fund is doing. However, they don’t tell you what factors impact the fund’s performance. This article explains in detail the various factors affecting mutual funds’ performance.
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1. Performance of the Securities in the Fund Portfolio
A mutual fund invests in a basket of securities (stocks and bonds) depending on the fund’s asset allocation and investment objective. Since the fund invests in specific securities, the fund’s performance is based on how well these securities do.
A fund’s investment objective can be to invest 65% of assets in equity and equity-related instruments and the remaining in debt securities. Thus, the fund’s portfolio that heavily invests in equity can take a hit in case of market turmoil.
However, fund managers can diversify their investments across sectors, market capitalisations, geographies, and so on, depending on the economic outlook.
If the fund portfolio is well-diversified and hedged well, the impact of the market downturn can be minimal. Therefore, the performance of the funds will largely depend on the performance of the securities in its portfolio.
2. Fund Management Team
The fund manager and the fund management team can significantly impact the fund’s performance. The fund manager and their team of experts manage investors’ money by investing them across securities that align with the fund’s investment objective. In addition, they actively manage the fund portfolio through periodic reviews and analysis. Thus, the fund manager’s security selection and investment timing have a significant impact on the fund’s performance.
Therefore, fund managers with good industry experience and track records tend to be more efficient in managing investors’ money. Hence, it is advisable to pick funds managed by experienced fund managers.
3. Economic Changes
In mutual fund investments, one of the most important things to keep in mind is how well the fund invests in a certain sector or industry. This is because some policy changes made by the government can have a significant impact on different parts of the economy in different ways. For instance, during the covid-19 pandemic, the healthcare industry wasn’t hit as much as the other sectors.
The stocks prices were more or less stable and have performed well compared to other industries. Similarly, one sector can perform well during a period and sometime may witness some stiffness.
If a mutual fund has high exposure to one sector, a positive trend will help the fund generate good returns. At the same time, if a policy change hurts a sector or industry, the fund performance will have a negative impact.
4. Expense Ratio
Mutual fund investments are managed by a fund manager and his team of experts. Since experts manage your money, the fund house charges a fee for management. This fee is known as the expense ratio.
All of the costs and fees that go into running and managing a mutual fund, such as management fees and distribution fees, are included in the expense ratio of a mutual fund.
As per SEBI guidelines, mutual fund houses cannot charge a total expense ratio of more than 2.25%. A higher expense ratio can reduce your net profit. Thus, it is ideal to find funds with a low expense ratio.
5. Fund Cash Flows
A mutual fund pools money from multiple investors. These investors have similar financial goals and risk tolerance levels. The fund invests across different stocks and bonds. If many investors wish to invest in the mutual fund scheme, the fund manager has more money to invest. As a result, the fund manager can invest across multiple securities with large assets and diversify the fund well.
On the contrary, if investors feel that a fund isn’t performing well, they might pull their money out of the fund. As a result, the fund manager will have to sell off some holdings to accommodate the redemption requests. This can hurt the fund’s cash flow and impact its performance.
6. Assets Under Management (AUM)
The size of the mutual fund plays a role in how well it does. Too much or too little funds can impact the fund’s performance. To elaborate, if the fund size becomes too big, it becomes difficult for the fund manager to maintain it.
There are a lot of essential factors to consider when investing in a mutual fund. It could be the size or the fund manager who manages it. The securities in the portfolio and the economic condition of the country all play an important role. Thus, it is critical to consider all the factors before investing.