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How to evaluate your fund's performance

Watch Dhirendra Kumar's simple, yet concrete advice on evaluating a fund's performance

Let me start by repeating what I keep saying-the very first step is to choose the right vehicle for your investment. For this, you need to segregate your needs in two parts-the money which would be required over a short period of time and the money which would be required for long-term goals. And then you have to choose the right type of fund. For your long-term goals, it can be a multi-cap fund or an aggressive hybrid fund.

Once you have done this exercise, there are two things to look at in terms of the performance of a fund. Firstly, find out how the fund is doing vis-a-vis its benchmark. Having a benchmark index is mandatory for every fund. When you entrust your money to a fund, you are simply asking the fund manager to deliver more returns than the benchmark index it is trying to defeat. You can anyways get index-like returns without much effort from a passive fund.

The other thing to look at is, how good is the fund when compared to its peers. That is where you look at the category average which Value Research computes for each and every category every day.

These two things are relatively simple, the tricky part is the time frame. If you start evaluating whether the fund is beating the benchmark on a day-to-day, week-on-week or a month-on-month basis, it will be a futile exercise. Looking too much into these numbers will not lead you anywhere.

The appropriate time frame to evaluate performance is different for different kind of funds. In a liquid fund, a weekly comparison is fine because that is the typical holding period of the investment. But when you are investing in the long-term products, say a pure equity fund or an aggressive hybrid fund, the appropriate time frame would be a full market cycle in my understanding. A full market cycle means a period which has been able to capture some part of both the phases of the market-rising as well as falling. Typically, this is around three to four years. If you look at any previous three to four year time-frame, you will figure out that it usually captures both the phases of the market.

So you have to evaluate the performance of equity funds over a three to four year period. If you get attracted to a fund which has done exceptionally well in a rising market, or a fund which has not fallen in a falling market, you haven't seen the other side of it. You may get disappointed later as your investment is going to be for many years.

To summarise, there are just two things to take care of. One is whether the fund is beating the benchmark in a somewhat consistent manner and whether it is doing better than others of its own kind. More importantly, this should be looked over an appropriate time frame.

Value Research Fund Ratings can be good starting point for this as it captures all of it. A five or a four star fund reflects superior risk-adjusted performance within that category. That apart, we rate funds only when they become at least three years old (in case of equity funds) which means that the essential track record is reflected.

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