How to choose an Equity MF?

Consistency of returns should matter more than the absolute returns, but there is no easy way to figure that out, up-until now

Discussing with a few friends/colleagues on their investment methodology and how they choose their equity mutual funds, gave me an insight. Bloody there is no framework which helps you shortlist/finalize a mutual fund. The max that we do is either/all of the following:

1. Go to sites like valueresearchonline, moneycontrol, morningstar or likes, filter the funds by the types (Large, Mid, Small, Flexi etc.) and look at the 1Yr or 3 Yr or 5 Yr performance and choose the highest returning one

2. Look at the ratings that the above sites gives and invest in the best ranking funds

3. Invest based on reference/word of mouth that another friend might have recommended (which probably gave him/her good returns so basically point 1 without doing own shortlisting)

4. If one wants to take an extra effort, then look at the stocks that the company is owning, and if there is some +ve (e.g. defence companies coz lot of Make-In India in defence is going on) or -ve news (e.g. Adani), make a judgement call and then invest

While I have nothing against either of the approaches (hell I used to do the same till a year ago), each of them have the same shortfall, i.e. most of them are backward looking and none of them tells if the performance is affected by one very good/bad year of performance (e.g. 10% every year vs 20%,30% and -15% across year 1,2,3) and therefore can you expect consistency when you invest.

Reading up a bit on the alternate approaches that one can consider to evaluate MFs, I came across the details sections on morningstar.in which has these risk ratios (sharing screenshot below for Parag Parikh Flexi Cap Direct Fund)

What captured my attention was the bottom right corner, the upside and downside capture ratio. What does it mean?

1. Upside Capture: If the benchmark moves by 1% how much does the fund moves, 100 or higher number is better

2. Downside Capture: If the benchmark falls by 1% how much does the fund falls, 100 or lower number is better

Why does it matter?

Well you want a fund that outperforms both on the upside as well as the downside, if not then you want a fund which outperforms more than it underperforms.

How to use this to determine the consistency of the fund manager?

As the definition tells, if a fund is able to go higher in the good times and fall lesser in the bad times, then you have a rock star at your hands. But to remove the noise of one-off years of superlative performance, what one needs to do is the following:

1. Look at each of the years individually, i.e. look at the Upside Capture (UC) and Downside Capture (DC) for each of the years separately

2. Marry this, with the fund’s performance against its benchmark’s performance for each of the years separately and not look at the cumulative performance

A consistent performance will tell you:

1. The performance is structural and not one-off

2. The fund manager is able to pick the right stocks at the right time and construct a portfolio where if the gains happens I gain a lot (>100 in UC) and if I go wrong then I dont loose much (<100 in DC)

Great, now I can start using these numbers from morning star and start deciding

Not so quickly, for some reason morningstar doesn’t provides this on a year on year basis (both UC DC and outperformance vs benchmark), and neither does it provides the user to filter MFs based on these ratios.

All of this gyaan, and I can’t use it; so what’s the use

Worry not, I did a lot of homework to create a self-use utility which can help investors in figuring out these ratios automatically and present you on a platter. But given the universe of MFs that exist, there would be some work that you as a user would also have to do, i.e. fill in the MFs that you want to evaluate, the benchmark against which you are comparing the performance and the google finance code for the same.. Refer screenshots later to understand what and how to do the same.

Link for the utility: Link

How to get data specific to your requirements:

1. Paste the name of the fund in Column B

2. Visit Google Finance: finance.google.com

3. Search for your mutual fund, ensure that the name and regular/direct are appropriately chosen (refer image below for Parag Parikh Flexi Cap Direct)

4. Copy the MF code that Google Finance displays, in this case “MUTF_IN: PARA_PARI_FLEX_17J17OL“

5. Copy the code, HOWEVER ENSURE THAT THE SPACE BETWEEN “MUTF_IN” and FUND NAME IS DELETED; therefore the code to be used is “MUTF_IN:PARA_PARI_FLEX_17J17OL”

6. Paste this in column F of the sheet

PLEASE ENSURE TO NOT DELETE ROWS, IF YOU WANT TO REMOVE SOME ROWS, PRESS DELETE BUTTON TO ERASE THE CONTENT OF THE CELLS

How to use the utility

Well once you have put the funds that you are considering for investments, you can see their year by year performance wrt UC, DC and Outperformance (OP).

While selecting the funds, you should consider:

1. Funds which are generally displaying Green cells in the latest years are more consistent performing

2. If there has been a sudden shift either from Red to Green or vice-versa, check if there has been a fund manager change which is causing the performance change (Details of fund manager are available on morningstar.in). If yes then wait for another 6 months to ensure that its not one-off

3. If you are seeing a lot of reds in a particular columns, see what date it corresponds to, for e.g. sitting in 2023, three years ago performance would be impacted by COVID-19 and therefore almost all of the funds would have under-performed

4. Most important of all, please create your own copy for your own consumption

Incase you are facing any issues in using this file, please drop a message in the comments section.