There are two ways of figuring out what kind of returns one can expect from mutual funds. One is to look at historical performance and assume that it will have a bearing on what happens in the future. The other is to develop a framework for figuring out what are the factors that drive returns and how they pan out in the future. Obviously, fixed-income funds and equity funds need to be looked at very differently.
Let's try and understand the framework that drives the returns of fixed-income funds first. The long-term returns of fixed income funds are anchored around the interest rates that prevail in the economy. These are decided in the monetary policy that the RBI formulates according to the modern theory of central banking, the overriding goal of the RBI's monetary policy should be to achieve stable and low inflation and the bank should keep interest rates high till this is achieved. While there are many more complexities in the practical situation, as an investor, you can expect the trend of fixed income returns to be around the prevailing inflation rate.
Different kinds of fixed-income funds would have slightly different returns. Funds with shorter maturities should ideally earn somewhat less. Funds with longer maturities would earn more and likely earn higher returns when rates fall.
The framework for equity is different. Empirical evidence suggests over a long period, you can expect stocks as a whole to grow about as much as nominal GDP does. If you compare the average GDP for five years ending 2000 with the average of the latest five years with the Sensex, then the GDP is up 5 times and the Sensex is up 4.6 times, which is a good enough indicator. There are all sorts of caveats to this -- the Sensex is not the same as all stocks but as a rule of thumb it's valid. This is of course a mean trend. You'll obviously earn more if you chose your funds well.
This article was originally published on November 01, 2013.
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