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How to Look at Returns?

While researching on mutual funds, is it better to look at six-month, one- three- or five-year returns? —Anooj Behanan

Equity funds are meant for long-term investors. Therefore, while investing in an equity find, one should look at its performance record over a longer time horizon. Looking at the returns over a period of 6 months or one year will hardly reveal anything about the fund. In fact, during an ongoing bull-run, some of the funds that deliver exceptional returns might turn out to be poor performers over a long time horizon.

However, even looking at the returns for a longer time horizon alone is not sufficient. One should not only look at the long term returns of the fund, but also break it down to shorter time intervals to see how consistent has the fund been. Thus, you should look at the returns that the fund has generated over a period of say, five to seven years, vis-à-vis its peers. Within such a time horizon, you should also look at its performance during shorter time horizons, for example quarterly or six-monthly returns.

Such comparison can give valuable insight as to how a fund has performed during different market cycles. For example, a fund may do exceedingly well during bullish phases, but also suffer heavy losses during the bearish cycles. On the other hand, another might deliver close to average returns across bullish and bearish phases. Both might end up with around the same 5-yearly return, but the former has been much more aggressive and volatile. Such a difference will also get reflected in the standard deviation of the two funds- the first one will have a much higher standard deviation. Which one should an investor go for depends upon his risk appetite.

While researching on mutual funds, returns should form just one parameter for comparison. One should also pay attention to the management style of the fund. This would include things like- Is the fund biased towards large-caps, or do mid- and small-caps form a substantial part of its portfolio? Does the fund prefer to concentrate in a few stocks and sectors, or does it maintain a well-diversified portfolio?

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