Over the past decade, mutual funds have become very popular among retail investors. This growing trend is largely due to the high returns offered by mutual funds and the declining returns from bank fixed deposits and small saving schemes, which have been affected by the prevalent low-interest-rate scenario.
Once retail investors have understood the fundamentals of mutual funds, they can start investing with greater confidence. To enhance their investment decisions and to enjoy the utmost benefits, it would be highly beneficial to learn the advanced strategies of Mutual Fund Investments.
Familiarising oneself with advanced concepts like portfolio analysis, statistical analysis, various investment strategies, and options will help one progress to an advanced level of investing.
Understanding the Metrics for Evaluating Mutual Fund Performance
Assessing the performance of mutual funds involves analysing various metrics using formulas such as Jensen’s alpha, annual standard deviation (SD) etc. Each of these metrics helps get an insight into different aspects of the fund’s performance. By studying these statistical measures, investors can gain a clearer understanding of how well a mutual fund is performing and make their investment decisions.
Jensen’s Alpha
Jensen’s alpha helps in evaluating a fund manager’s performance relative to the market. This metric helps understand how effective the returns of a mutual fund are after considering the risks taken. A positive Jensen’s alpha indicates that the fund manager has performed well at the given level of risk. Conversely, a negative value suggests that the performance is lacking relative to the risk undertaken.
Jenson’s alpha formula=R(I)-(R(f)+B*(R(m)-R(f)))
Where:
R (I) = expected return of the portfolio
R (M) = expected return of the appropriate market index
B = beta of the portfolio
R (f) = risk-free rate of return for the time.
Standard Deviation (Annual SD)
Annual standard deviation is a statistical measure used to assess the volatility of a mutual fund. A high standard deviation indicates that the fund’s returns are highly volatile, meaning it could achieve significant gains or suffer substantial losses. Conversely, a low standard deviation suggests that the fund’s returns are more stable and less prone to large fluctuations. For instance, debt funds typically exhibit lower annual standard deviation due to their relative stability and lower risk.
Sharpe Ratio
The Sharpe ratio is used to measure a fund’s performance relative to a risk-free investment, like fixed deposits. It helps investors determine whether that specific mutual fund provides returns justifying the risks taken compared to a risk-free return. Generally, if a mutual fund’s performance is below the risk-free rate (which is generally around 6-7%), it would be advisable to consider a different, better-performing fund.
The resulting Sharpe ratio, which ranges from 0 to 100, indicates the quality of returns relative to the risk taken. A higher Sharpe ratio signifies better risk-adjusted returns.
Mutual Fund Investment Strategies
Asset Allocation
Asset allocation involves diversifying the portfolio by spreading investments across various asset classes. This strategy helps investors mitigate losses from a poorly performing fund by earning from a high-performing fund. By balancing investments among different asset categories, investors can reduce the impact of any single fund’s negative performance on their entire portfolio.
Rupee Cost Averaging
Rupee cost averaging is a strategy where investors purchase mutual fund units consistently over time, irrespective of the market fluctuations. This strategy helps investors in acquiring units at varying prices, aiming to lower the average cost per unit. Systematic Investment Plans (SIPs) are a common method for implementing this strategy, especially during periods of market volatility.
Top-Down Investing
The top-down investment approach focuses on macroeconomic factors to make investment decisions. For example, if foreign companies start establishing car manufacturing units in India, this indicates potential growth in the automobile sector. By investing in a mutual fund focused on the automobile industry based on this macroeconomic trend, you are engaging in top-down investing.
Bottom-Up Investing
The bottom-up investment approach focuses on evaluating individual companies rather than macroeconomic factors. For example, if a technology company demonstrates a strong annual growth rate of 110%, and similar bullish trends are observed in other technology-related companies, investing in a technology mutual fund based on these specific company performances represents bottom-up investing.
Value and Growth Investing
Value and growth investment strategy focuses on selecting investments based on their potential for value appreciation and growth. Value investing involves identifying undervalued stocks or companies having solid financial fundamentals and investing in them. Growth investing involves investing in companies with promising growth prospects.
Now that you have gained insight into advanced mutual fund investment strategies, let’s discuss how to monitor your portfolio when you are satisfied with its performance. This is where portfolio analysis techniques become essential for evaluating your investments effectively.
Final Words
An advanced Mutual Fund investment strategy helps in eliminating poor investment decisions and increases the chances of success. One can start by asking themselves fundamental questions like How much am I willing to invest? What returns do I aim to achieve? What is my risk tolerance? What is my time horizon? What are my investment goals?
Once you have clarity on these objectives you will be able to make better decisions about investments. It’s advisable to remain vigilant for promising opportunities and avoid investing all the funds at once. Building a portfolio is like constructing a house—one step at a time, gradually adding to it with each investment.
Gainn Fintech was established to offer- a trustworthy, dependable, and resilient trading platform, empowering investors to pursue their aspirations and achieve their objectives. We chose the name Gainn to signify the impact we aim to create in our clients’ portfolios. Our goal is to assist clients in gaining and multiplying their hard-earned wealth effectively.
