Selecting Mutual Funds

09Jun10

I have been thinking for sometime about investing in MFs. Why MFs? It’s simply because I am not yet confident that I can beat the market by 4-5% over a long time period. Though many MFs do not perform better than the Sensex once adjusted for the expenses/commissions, I think one maybe able to find a handful doing better than the Sensex over the long-term. Just like stocks, this analysis is definitely based on looking at the rearview mirror and hoping the future performance will not be much worse when compared to the past.

I plan to invest 60% of my monthly savings in MFs and I would invest the remaining 40% directly in the markets. But since I may not be able to find investment opportunities every month I would park these funds in some liquid fund which I have not yet determined. If at all I am able to beat the market over a 3-5 year period and I also seem to beat the performance of the MFs I have invested in, I would then change this 60:40 ratio.

I have not yet selected the MFs though have shortlisted a few which I would study further.

My approach:

1. Rank the equity funds based on 5 year returns and 10 year returns from http://www.valueresearchonline.com

2. Compare the performance of the top 10 funds over various time periods (1Y,3Y,5Y,10Y)

3. Do not consider MFs not around for 5 years. Do not take returns for last 6 months or less very seriously.

4. Find the average returns for the top 10 funds across various time periods and see how each fund has beaten the average returns across time periods. Also find how the MFs have beaten the benchmark over various time periods.

5. I do like consistency in performance across time periods since I cannot closely watch what the fund manager is doing nor do I have the competency to evaluate what he is doing.

6. I do not plan to withdraw funds anytime soon and hence do not believe that volatility is a measure of risk of the fund. Hence will not look at sharpe ratios and betas. None of the funds are leveraged and hence that risk is also non-existent.

7. After this exercise, I would subtract the expense ratios across time periods for all these funds to understand how their returns stack up on an expense adjusted basis. I would again compare the expense adjusted returns across time periods for the funds with the average to see how they perform now. Though this may not be the right method to calculate the effect of expense on the funds performance, I could not think of a better method.(Thanks to Siddharth for correcting this mistake. The NAVs are post expense and hence returns indicated are after deducting expense.)

These are the excel sheets I used for my analysis:

EQUITY DIVERSIFIED FUNDS (RANKED BASED ON TOP 10 FIVE YEAR RETURNS AND THEN TOP 10 TEN YEAR RETURNS)

The returns highlighted in RED indicate that the return during that period was lesser than the average of the Top 10. I just wanted to  see how consistently they are able to beat the average of the Top 10 funds in the category chosen. Please note that this is not the Average of all funds in the category but Average of Top 10. Hence that is a pretty high benchmark.

I liked the performance of the 4 funds highlighted (in yellow). Some observations:

-> ICICI pru dynamic has not been around for 10 years nor have they really excelled in their 5 years of existence. So am not considering them.

-> The performance of “Reliance growth” has been very consistent. They have beaten the benchmark across various time periods and have also beaten the average of top 10 across time periods.

-> HDFC Top 100 and HDFC Equity, both seem to have done a very good job. Except for the 7 year period when both of them have been slightly below average, across all other time periods they have beaten the benchmark consistently and comfortably.

-> DSP Blackrock equity has not performed well at all in the 10 year returns category though they seem to have done a good job post that period.

So, among the equity diversified funds, I would look at the 4 highlighted and choose 3 or all 4 based on whether I am able to eliminate 1.

1. Reliance Growth

2. Preferably one out of HDFC 200 and HDFC Equity (Both are managed by the same fund manager and seem to have very similar return patterns. Need to delve deeper.)

3. DSP Blackrock Equity

EQUITY TAX SAVER FUNDS (RANKED BASED ON TOP 10 FIVE YEAR RETURNS AND THEN TOP 10 TEN YEAR RETURNS)


The “TAX saver/ELSS” funds have not performed as well as “Equity diversified”. The average performance of the top 10 has tracked the sensex in the 1/3/5 year time frames. Is it because of taking on more debt? I haven’t tried finding it out yet.

However, interestingly there are not too many common top performers across the 5 year and 10 year horizons.

One can observe that on an average expense ratios of Tax Saver funds are higher than that of Equity Diversified funds coupled with lower retuns. Since I have a pretty long time frame I have not considered volatility of returns on a day to day basis to measure the risk or risk adjusted returns.

The six funds which initially interested me were:

1. Canara Robeco – Though a poor performer in the initial few years, due to a change in Fund Manager and partnering with Robeco, the fund has performed very well in the last 5 years. Their AUM is low at 150-200 crores. Hence also a higher expense ratio of 2.48%. But still their performance over 1/3/5 year periods is pretty good I would consider them.

2. Sahara Tax Gain – Though the numbers look good, AUM is just 10 crores. So dropped them later on. Nor does the brand name Sahara inspire confidence. I am not sure whether they would be around 5 years from now.

3. Sundaram BNP Paribas Tax Saver – In the last 1 year they have done pretty badly compared to peers but better than the benchmark. Otherwise they have done a reasonably good job compared to peers over the 5/10 year periods. Will be considering them.

4. HDFC Tax Saver: Consistently beaten the average and done a good job over both short and long-term. Would consider them.

5. ICICI prudential Tax Plan: Reasonably good performance across time periods post expense, except maybe the 5 year period.

6. Franklin India Tax Shield: Consistent performance but have not beaten the benchmark by more than 3% even in the 7/10 year period whereas other funds have been able to do the same. They closely track the benchmark with a 2-3% return above benchmark. I would expect over a 10 year period that few MFs must perform 4-5% above benchmark. This does not meet that criteria.

Hence from the 6 I initially looked at, I am narrowing it down to 4:

1. HDFC Tax Saver

2. Canara Robeco Equity Tax Saver

3. ICICI prudential Tax Plan

4. Sundaram BNP Paribas Tax Saver

Out of the 4 shortlisted in Equity Diversified and 4 shortlisted in Tax Saver category, I may choose to bring it down to 3 in each or make it 4/2 if needed. I would not like to hold on to all 8 since it would make it difficult to manage and track their performance. I would be reading a bit about the various fund managers and funds to understand how they think and whether I would be willing to give them my money. That may help me reduce the number to 6 from 8.

Kindly do your own research before investing. I am not liable for the same. This is not a recommendation and there is no conflict of interest.

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5 Responses to “Selecting Mutual Funds”

  1. Hi Pradeep,
    Interesting analysis, a few minor typos here & there i guess like it is DSP Blackrock i think not DSB. However i didn’t understand why you are subtracting expenses from the returns?? As far as i know the NAVs are inclusive of the expenses & hence i am assuming the returns shown are for NAV growth,so expenses are already included & you are double counting.

    • Hi Siddharth, Thanks for pointing out the typos. I hopefully have corrected them. And thanks for pointing out the flaw in calculating returns adjusted for expenses. Have removed that part from my analysis.

  2. 3 Hima

    excellent article .. I was looking for a article to share with my friends .. this one one nails pretty much everything I wanted to say .. ICICI prudential Tax Plan was one of my first mutual fund investment .. I have been investing in it since 5 years through SIP

  3. 5 Ramnath Rangaswamy

    Good analysis! Very systematic!

    Just for my information where did you get data for 10 years and 7 years returns? Or did you do the calculations yourself based on NAV?

    Great work!


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