Part II Are you a Mutual Fund Investor? You need to know this

"A wealthy person is simply someone who has learned how to make money when they are not working"

-Robert Kiyosaki

One powerful line that changed my life-

"If you improve yourself  by 1% every day, in a years time you would have improved by 365%"

Now, let us begin our journey of being a member of a niche group that investigates and understands before investing:

Out of the 5 points, we have covered 2. If  you are new to this blog I will advise first read 

 PART I (👈link), to understand this better:

Lets us have a quick revision:

1. Before Investing, we should Investigate
2. When investing in MF, we should at least check these 5 parameters- Total Expense Ratio (TER), Standard Deviation (SD), Beta, Alpha and Sharpe Ratio
3. TER: Informs us, what portion of our money is being used by the fund management team as a fee. A very critical piece of information especially if we are long term investors 
4. SD: Informs us in advance, what kind of a swing we can expect relative to the market

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Let us move forward and understand the next 3 parameters: 

3. Beta:

It predicts the performance of the fund in the correlation to its index. Do not let these jargons scare you, we will only learn the application of the data everything else is already available online. 

The Beta of an Index is always 1 and Beta of our MF will help us predict the performance of our MF in relation to the index.

Significance:

Suppose the Beta of an MF is 1.2

How should you interpret this data?

If you have invested in a Large Cap MF and the Large cap index has delivered 10%

Now, when the index delivers 10% your MF should deliver 12%

(Index return 10 * Beta 1.2 = 12)

When the index delivers  -10% your MF will ideally deliver -12%

(Index return -10 * Beta 1.2 = -12)

Higher Beta indicates better returns in the Bull market and bigger loss in a bear market.

Now that you have understood Beta, do apply this before making an investment and ask yourself are you ok with this kind of the fund.

Invest only if your answer is YES

A high beta fund can justify the high-risk strategy only if they are generating Alpha. 

Now let us quickly look and understand Alpha.

4. Alpha:

We just learned the MF with a beta of 1.2 will deliver the 12% returns when the index delivered 10% Now, please note12% is already predicted.

Let us assume, our MF delivered 15% returns when the beta was 1.2. Here the MF has successfully delivered an extra 3%. This is Alpha

Alpha = Actual Return - Predicted Returns

           = 15-12

           = 3

Most people assume, Alpha is returns generated over and above the index, however, Alpha indicates the returns generated over and above the predicted return of the fund.

Alpha generated by a fund, is essentially the value added by a fund manager. This gives us a sense of the fund manager’s smart investing ability.

The results of these [investment] companies in some ways resemble the activity of a duck sitting on a pond. When the water (the market) rises, the duck rises; when it falls, back goes the duck I think the duck can only take the credit (or blame) for his own activities. The rise and fall of the lake is hardly something for him to quack about. The water level has been of great importance to BPL’s performance. However, we have also occasionally flapped our wings.”

-Warren Buffett

Do check if your Fund Manager is flapping his wings or not, by looking at the Alpha of the fund.

Last but definitely not the least, this ratio is one of the most crucial data points, if you make your investments without checking this, call yourself a gambler and not an investor.

5. Sharpe Ratio (SR): 

Some mutual funds produce huge profits in the short run, followed by heavy losses. 

Is there any way to detect such funds before investing?

The answer is the Sharpe Ratio. It evaluates risk and reward together.

SR will help us select products that might generate higher returns but with optimal risk. It indicates return generated per unit for the risk taken.

Significance:

If we have to select between 2 funds within the same category, for example:

1. HDFC Large Cap
2. Axis Large Cap

SR of HDFC is 1.7 and that of AXIS is 1.4 now it becomes very simple we should select HDFC as they have a higher SR. Which implies they will generate better risk-adjusted returns. It is believed higher the SR the better it is. However, it is advised to look at SR along with the other 5 parameters we discussed.

Congratulations, you are amongst the few people, who can understand the exact application of these financial jargons.

Now, just for fun if someone approaches you as a financial advisor do check these terms and examine if they have an understanding of these ratios. If they don't please do not get violent :)

Regrettably, 90% of the advisors do not take the pain of looking into these ratios and 50% do not know what these terms mean.

Let me recommend a site, that will give you all these data points at one place so that you do not have to depend on people to share this information with you. Just click here and follow these steps. 

 1

In the search box enter the name of the MF you want to invest

2

You will get the TER right at the top of the page, highlighted in yellow 

3

Now Press Ctrl F and type in any of the 4 ratios you are looking for 

Remember your money, your responsibility.

I received a few emails after my last blog on VALUE INVESTING asking for recommendations, so writing two lines on it.

Mutual Fund Recommendations:

My personal investments are either in direct stocks or ETF/Index funds for 2 reasons- 

1. Globally there are hardly any managed mutual funds that can beat the index in the long run.
2. Direct stocks/ETFs/Index funds are cheaper with no entry or exit load.

I will write about ETF and Index fund as soon as possible. Kindly let me know should I cover various categories of Mutual fund (Large Cap, Midcap, Multi-Cap Etc) or can I move to ETF's. Your feedback will help me decide the next topic.

To Summarize-

Irrespective of how good your fund is, when the stock market drops every fund will fall. Currently, the stock market is trading at a very high and expensive level. Avoid making any lump sum investment, any investment that you make has to be via SIP (Systematic Investment Plan)

This was my personal attempt to help you. If this article was beneficial, kindly share it with your near and dear ones.

I would be very glad to hear your feedback, in fact, it will motivate me to continue my journey of a blog and teach.

Thanks and I wish and hope you make a lot of wealth from your investments.

All the best!! 👍👍👍

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