Looking back on 2016, your equity funds have not matched up to your expectations. Where did those 20% returns go? Should you sell your fund? Don’t do that just yet. Remember that you never look at a fund’s performance in isolation. So how do you tell if your fund is doing well? Answer these questions first.
Is it able to beat the market?
A fund aims at delivering returns higher than the market. By market, the fund means its benchmark. A fund generates these returns based on stock price movements. At a time when the stock market itself goes nowhere (2015 and 2016 are great examples of such a flat period), how is your fund supposed to generate those high double-digit returns? So when you look at the fund’s return, always look at what its benchmark is doing. As long as the fund has done better than its benchmark – which is its purpose – your fund is doing fine. Take Franklin India Bluechip, for example. Its 1-year return is 4.5%. Not good, in your book. But the fund’s benchmark is the Sensex. This index has gained 0.7% for one year. The fund has, therefore, delivered almost 4 percentage points more than the market. That poor return looks healthier now! Fund aggregator websites always provide returns of both the fund and its benchmark.
Is it able to beat its peers?
So the fund beats its benchmark. You can find several that manage that! Move to the next step. The fund should additionally be able to beat its category. Doing better than both its benchmark and its category is the hallmark of a good fund. If it is not able to beat category average, it means that there are better funds out there.
By category, we mean the general type of fund it is. You need to compare similar funds only. An equity fund will invest in only large-cap stocks (largecap fund), or only in mid-cap and small-cap stocks (midcap/smallcap funds) or in a mix of these (diversified funds). A debt fund will invest in very short-term papers (liquid and ultrashort term funds), or short term papers (short-term funds), or long-term papers (income funds), or lower-quality papers (credit opportunity funds), or government bonds (gilt funds), or a mixture (dynamic bond funds). Each category has a different driver of performance. Each set behaves differently in different market cycles.
Continue the example above. You look at the 11% return of Mirae Asset Emerging Bluechip and decide that’s a better fund than Franklin India Bluechip. But Mirae Asset Emerging Bluechip is a mid-cap fund and the Franklin fund is a largecap fund through and through. 2016 was a year when mid-cap and small-cap stocks soared far ahead of large-cap stocks. Would it be fair to a large-cap fund, then, to compare it to a mid-cap fund? You’re right, it wouldn’t! Always compare a fund to its own category to get the right picture.
Has it always beaten benchmark and category?
Today, you look at returns and you see that the fund has delivered better than the benchmark and the category. Was it able to do that last year? Two years ago? A fund should be able to deliver benchmark-beating and category-beating performance at all times. In other words, it should consistently be an above-average performer. Checking consistency in performance is important. There is little benefit in holding a fund that alternately outperforms and underperforms by a wide margin. A consistency metric will tell you if a fund’s strategy enables it to pick a reasonable number of winners in all market cycles, all the time.
Looking merely at the 1, 3, and 5-year returns on a single day will not tell you anything about consistency. Ideally, the way to gauge consistency is to roll the annual returns daily for three years at least, or even five years. That can be tough for you to do. So you can look at returns in each calendar year, which you can calculate yourself or obtain from aggregator websites. Fund factsheets provide one-year returns for three consecutive years at the end of each quarter for each fund and its benchmark. Pick up the factsheet in different quarters for different years to measure consistency.
Past record will also tell you if you should allow the fund more time to perform. Your fund may underperform sometimes and recover later. You can give a fund that has been consistent in performance so far some leeway if it is not up to the mark right now.
There are several other metrics and ratios to judge fund performance, not to mention fund strategy and the fund manager. But if you have ticked off yes to the three questions above, it answers a significant part of the performance question. It’s also a good enough yardstick to address your worry when you see those return numbers ticking down.