Introduction
In Indian Scenario, Mutual Fund is a corporate body registered with SEBI (Securities Exchange Board of India) that pools money from individuals/corporate investors and invests the same in a variety of different financial instruments or securities such as equity shares, Government securities, Bonds, debentures etc. Mutual funds can thus be considered as financial intermediaries in the investment business that collect funds from the public and invest on behalf of the investors.
The fund performance depends on
1) Type of the funds
2) Investment objective of the fund
3) Current financial market conditions
The most common performance measures of the fund are
1) Change in Net Asset Value (NAV)
2) Total Return
3) Total Return with dividend reinvested at NAV
4) Expense Ratio
5) Income Ratio
6) Portfolio turnover Rate
7) Transaction Cost
8) Fund Size
9) Cash Holdings
10) Borrowing by Mutual Funds
1) Change in NAV
The price or value of one unit of a fund. It is calculated by summing the current market values of all securities held by the fund, adding in cash and any accrued income, then subtracting liabilities and dividing the result by the number of units outstanding.
NAV or Net Asset Value of the fund is the cumulative market value of the assets of the fund net of its liabilities. Buying and selling into funds are done on the basis of NAV-related prices.
For NAV change in percentage terms –
Formula is
(Absolute change in NAV/ NAV at beginning) * 100
If period cover is less or more than one year annualized NAV change is given as
(((Absolute change in NAV/ NAV at beginning)/ Months covered)*12)*100)
Example
NAV at beginning = Rs50. NAV after 10 months =Rs60
Therefore annualized NAV change is ((((60-50)/50)/10) *12)*100 = 24%
Limitations- It does not take in to account the dividend distributed by the fund to investors in the interim period.
2) Total Return
This method corrects the limitations of the NAV change measure.
Formula for total return is
((Distributions + Change in NAV) / NAV at beginning)*100
Example
NAV at beginning = Rs50. NAV after 1Year =Rs60.
Interim dividend distribution Rs5 per unit.
Therefore total return at year end - ((5+ (60-50))/50)*100=30%
Limitation- This method ignores the fact the distributed dividends also get reinvested if received during the year.
3) Total Return with dividend reinvested at NAV
Total return with reinvestment is a measure of cumulative wealth accumulation.
Formula is
((((1+div/ex-dNAV)*endNAV) - begin NAV)/begin NAV) *100
Example
Investor purchased one unit at Rs50 per unit. NAV after 1Year = Rs60. Interim dividend distribution Rs5 per unit when NAV was Rs55. The distribution of Rs5 was reinvested in the fund at Rs55 per unit, giving the investor 5/55 = 0.09 unit, making his total holding 1.09 units.
Therefore the actual return at year end (65.4-50)/50 *100= 30.8%.
Note that this is higher than simple total return of 30% calculated by the previous method.
While computing these returns the following points need to be taken care of
1) Effect of loads – The above examples assume no load funds. In reality the investment amount will be lower if there is an entry load. Therefore the investor’s return has to be reduced by the initial load paid.
2) Time period -While computing the returns it is imperative to use the performance data over the same time period for two different funds.
4) Expense Ratio
Expense Ratio is an indicator of funds efficiency and cost effectiveness .It is defined as a ratio of total expenses to average net assets of the fund.
For example funds with small corpus size will have a higher expense ratio affecting investor returns than a large corpus fund.
5) Income Ratio
A Fund’s Income Ratio is defined as its net investment income divided by its net assets for the period.
The ratio is a useful measure for evaluating income–oriented funds, particularly debt funds. It is not recommended for funds that concentrate primarily on capital appreciation.
6) Portfolio Turnover Rate
Portfolio Turnover Rate measures the amount of buying and selling of securities done by a fund. It is defined as the lesser of asset purchased or sold divided by the fund’s net assets.
This percentage is a good indicator of the extent to which the fund is active in market deals. However high turnover rate indicates high transaction cost charged to the fund.
High turnover rate does not necessarily mean greater efficiency and for newly launched schemes that are not yet fully invested, it is not meaningful to use the turnover rate.
7) Transaction Costs
Transaction costs include all expenses related to trading such as brokerage commissions paid, stamp duty on transfers, registrars’ fees and custodians’ fees. Therefore transaction cost has a significant bearing on fund performance and its total return.
8) Fund size
Small fund are easier to maneuver and can achieve its objectives in a focused manner. Large funds gain through greater risk bearing and management capacity.
9) Cash Holdings
The percentage of a fund’s portfolio held in cash can be an important element in its successful performance. Large cash holding increases a fund’s liquidity, cushions it’s against decline of market prices of shares and bonds and guard against large, consistent net redemptions. But large cash reserves lower the return on the portfolio.
10) Borrowing by Mutual Funds
Borrowing enhances per unit earnings and this strategy holds good when interest rates are not very high. In general, in India, Mutual Funds are not allowed to borrow to increase their corpus.
SEBI Regulations allow Mutual Funds to borrow only for the purpose of meeting temporary liquidity needs for a period of not more than six months and to the extent of 20 percent of its net assets.
Criteria for peer group comparison
Only funds with similar characteristics can be compared .Some important criteria for fund comparison are
a) The investment objectives and risk profiles – Two funds having the same investment objectives and risk profiles should be compared. For example it will not be appropriate to compare an equity fund with a debt fund because the former target growths and high capital gains, whereas the later is meant for risk-averse investor and focuses on regular income.
b) Portfolio composition -Portfolio composition of two funds should be similar. For example, a government securities fund can not be compared with another scheme that invests in riskier corporate debt.
c) The credit quality and maturity profile - For two debt funds credit quality as indicated by percentage of investment made in instruments with different ratings should be similar and the average maturity period should also be similar.
d) Fund size - It is advisable to keep fund size in mind and compare two funds of the same size. Big funds have greater diversification benefits such as risk sharing, while small funds are easier to manage for quick adjustments.
e) Expense ratio- Funds performance can be impacted with high and low expense ratio.
Even for two funds with similar characteristics as specified above, there returns must be calculated on a comparable basis. Hence,
1. Returns of two funds should be compared over the same periods only
2. Only average annualized compound returns are comparable.
3. Only after–tax returns of two different schemes should be compared.
Evaluating the Fund Manager/Asset Management Company
The investor must evaluate the fund manager’s track record. Good fund managers have the following characteristics.
1. Operate with a long term perspective
2. Do not sacrifice investor value by excessive trading which generates high level of transaction costs.
3. Turn out more consistent performance
4. At least match major market indices
5. Able to sustain bearish market phases better than other funds
An external credit rating agency – CRISIL – provides a FUND MANAGEMENT PRACTICE RATING on overall fund management quality and best practices followed by an Asset Management Company.
References: information collected from newspapers articles and materials from various websites. merely its a collection and not my work.. i jus collected and presented it.. i framed this for my publication in my college magazine but i didnt publised it... sorry i cudnt remb the websites i searched that time... before 10 months
i think my thread went much in depth.. i ll make it simple wen i gets time..
