August 14, 2019

Are you doing enough research before picking a fund?

Hemant Agarwal
Founder, Rupaiyaah

Are you doing enough research before picking a fund?


Humans are often faced with multiple choices in almost every walk of life, from amongst which they must choose. Be it a decision of buying a house, choosing a career or even buying a new phone, we must evaluate between multiple options and choose the most suitable one(s). Why should investing be any different?

Advisors play an important role in helping clients identify their goals and choose the right investment products to meet these goals. There are choices to be made at every step, which asset classes to choose, in what proportion to invest, what the tenor of the investments should be and more importantly which funds to invest in.  Research plays an important role in making each of these decisions. Let’s focus a little more on the importance of research in fund selection. Not only does it help you choose the right sets of funds suitable for your client’s portfolio, but also helps you anchor investor expectations especially during unfavorable times.

World over, historical performance is used as the universal metric by investors to select funds. Unfortunately, relying purely on past performance is like directly jumping to the last chapter of a rather engaging book; without reading and understanding the preceding chapters it would make very little sense. Similarly understanding the fund mandates and investment styles play an important role in assessing funds.

While SEBI categorization has come a long way in helping investors compare funds across comparable peer groups, we think it’s only the start of the selection exercise. Advisors should guide investors away from making decisions purely on performance comparison. Performance should be the end result of having a strong & experienced investment team, great investment process which is consistently plied, good risk management practices, etc, rather than being at the right place at the right time. The research will help you separate skill from luck. Performance backed by these factors tends to be repeatable going ahead as well.

Let’s take an example of two funds in the recently created Large & Mid Cap Category:

Looking purely at returns or even risk-adjusted returns seem to suggest that Fund A is a better proposition than Fund B. But is that necessarily the case?Table 1




Fund A (Historical Market Cap Allocations)

Picture 1

Fund B (Historical Market Cap Allocations)

Picture 2

The above charts clearly show that historically Fund A has had a significantly higher allocation to Small & Mid-cap stocks, while Fund B has historically had a significant allocation towards Large Cap Stocks. This explains that the outsized performance Fund A has is primarily due to its higher mid & small-cap exposure. Post recategorization, both funds have realigned their portfolios in line with the category mandate. By simply looking at the performance you will always empirically decide that Fund A is a better strategy. But having assessed the historical portfolio breakup across market capitalizations you can understand why Fund A may have performed better in the past and more importantly may not necessarily do so going forward, given its change in investment strategy. Past returns do not factor in for a change in investment strategy, style drift or change in management altogether. Research helps you tie all this together.

Similarly, when comparing funds in the fixed income category, returns may tell you one thing, but in-depth research in the understanding of the investment strategy of both funds gives you better insights as to which fund is more suited for your investor.

These are two funds from the Medium Duration category:

Fund A (Portfolio Credit Breakup)

Picture 3


Fund B (Portfolio Credit Breakup)

Picture 4

It is evident that Fund A has gone down the credit curve to generate additional returns, while Fund B has a pure AAA-rated portfolio. This information will not be readily apparent by looking at returns, but by researching the underlying mandates of the funds and the skill sets of the managers we get better insights into the risk-return profile of each fund and can accordingly choose a fund that is apt for your investor’s portfolio.

Researching funds not only help you pick funds but also lets you assess the performance of a portfolio of funds from the context of their strategy and the market cycle. This helps you make a call whether to hold or sell out of a fund. For instance, in 2017 growth and momentum were the major factors at work in the Indian markets. Expectedly, funds that had a value tilt underperformed during this period. Understanding this context would have made it easier to explain to clients why they needed to stay invested in these funds despite their short-term underperformance.

Research should be an integral part of each advisor’s value proposition which allows them to pick, manage and effectively communicate to investors the role of funds in their portfolio.

Quoting Forrest Gump….”Life is like a box of chocolates; you never know what you gonna get”. It’s not too different when it comes to the markets. There are several unknowns that can’t be predicted in the markets, but if one does meticulous research you will be better prepared to handhold clients to navigate through turbulence and help them achieve their financial goals.

4 Thoughts to “Are you doing enough research before picking a fund?”

  1. Thanks for sharing your views. These are important.

  2. Avatar Vignesh Kamath says:

    Where or how does one obtain the Charts shown in this article.

  3. It is easier said than done

  4. Avatar Sanjeev Mundhra says:

    Times surely are changing
    As advisor we need to be more discipline in picking up funds before advising
    A good research tool and knowledge can make our advise better

Share Your Thoughts