How to analyse the performance of a fund?

Padmaja Choudhury   /   July 3, 2023

Before investing in a mutual fund, it is important to analyse the performance of the fund. Most of us simply look at the returns of mutual funds and invest as per our friend’s suggestions.

However, there are better ways to analyse the performance of a fund. In this article, we will discuss some key parameters that can help us analyse a mutual fund.

Check the Fund’s Rolling Returns

Compounded Annual Growth Rate (CA­­­GR) is the most common type of return that is used to measure the fund’s performance over a specific period. However, CAGR shows the fund’s performance as of a specific date. It does not show the performance of the fund during the entire period.

On the other hand, rolling returns show the scheme’s annualised returns taken for the specific rolling returns period, e.g., one year over a specific period, say 10 years. In this case, the fund’s rolling returns will consider the one-year return the fund gave daily during these 10 years.

The rolling returns data gives us a better picture of the fund’s consistency and how the fund has performed over time.

Compare The Performance of an Actively-Managed Mutual Fund With Its Benchmark

As investors, if we are investing in an actively-managed mutual fund that a fund manager manages, we will expect the fund to provide higher returns than the benchmark index.

The benchmark index is the broader market index used to judge the fund’s performance. Depending on the type of mutual fund, every mutual fund has a specific benchmark index.

For example, Nifty 50 can be a benchmark index for large cap funds. If a fund gives higher returns than the benchmark index, we can say that it has performed better than its benchmark.

So, when analysing two funds of the same category, if Fund A has beaten its benchmark by a higher degree than Fund B, we can say that Fund A has performed better than Fund B.

Check the Fund’s Consistency

The second way to analyse the performance of a fund is to check the returns consistency of the fund. To do this, we can check the fund’s performance during various time periods and business cycles.

It is easier for a fund to give good returns during a market rally. However, we can see the fund’s real mettle during tough periods when the markets are trending lower. If the fund has consistently beaten its benchmark and peers over the long term, say ten years or more when the market was trending downwards, it is a better performer than other funds.

Conduct Peer-to-Peer Comparisons

In addition to comparing the fund’s performance against its benchmark, we can check its returns against its peers. Here, a large cap fund is compared against other large cap funds.

For instance, a fund might have beaten the benchmark by 1%, but if other funds have beaten the same benchmark by more than 1%, then the fund we are analysing has performed poorly compared to its peers.

Check Sharpe Ratio or Risk-adjusted Returns

We know that every mutual fund carries risk, although the risk of the funds will depend on the fund category. Typically, debt funds carry lower risks than equity funds in the short run.

A high return generally comes on the back of high risks. So, we expect a fund to take a high risk to generate high returns.

However, we need to see if the fund delivers high returns for every extra unit of risk taken. This shows if the fund can handle the risk they have taken in a much more effective way.

The Sharpe Ratio helps us check if the fund is giving higher returns for every extra unit of risk.

A higher Sharpe ratio indicates a better risk-adjusted return. It means the fund is giving higher returns relative to its risk than other mutual funds, so when comparing two mutual funds, the fund with the higher Sharpe ratio is the better fund.

When analysing a fund’s performance, it’s essential to consider these various factors that can provide insights into its past, present, and potential future performance.

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