May 6, 2007

My approach to selecting equity based funds

My previous post was on my roller coaster ride with mutual funds. I have hopefully learnt from my mistakes and used this learning to develop an approach to selecting and investing in mutual funds. It is not an original or path breaking approach in itself. However it works well for me (based on my personal risk and return preferences).

My expectations from my mutual fund portfolio is around 3-4% extra returns over and above the market returns (including the index funds in the portfolio) net of expenses. I consider this level of additional returns to be quite fair considering the low amount of effort and time involved in managing a mutual fund portfolio.

I have now developed the following approach to select mutual funds. In addition, this is an evolving approach

1. Invest in diversified equity funds with a long history of performance. I typically do not invest in funds with less than 5 years of performance history. The fund should have outperformed the relevant index by 3-4% during the period (net of expenses)
2.Analyse the performance of the fund over one bull and one bear market cycle. This ensures that I am able to see how the fund performed during the bear market and what kind of risk the fund manager was taking during the bull market. There are a lot of fund managers who will ride the latest fad, gather assets and then when the fad passes, the fund would tank completely. I try to avoid such fly by night jokers.
3.Select funds which have beaten the market returns by 3-4 % per annum for the last 5 or more years. Why invest in a fund which cannot outperform the market over the long run and pay fees for that?
4.Check the expense ratios and turnover for the fund. Unfortunately most of the funds in India over charge and only a few have the performance to justify such steep charges. I agree on this with the comments on my earlier posts. I try to select a fund with the lowest expense ratio as far as possible.
5.Check the following additional parameters for a fund. (http://www.valueresearchonline.com/ is a good website for that. It gives a fund summary for most of the top mutual funds)
a.Total asset under management – Should be more than 500 crs.
b.Fund alpha – this indicates the level of outperformance of the fund based on the risk taken by the fund
c.Fund beta, sharpe ratio, standard deviation etc
d.Mutual fund manager profile – how long has the manager been with the fund. Is it a new manager and hence the past performance not indicative of the future performance?. I also try to read interviews of the manager if I can get access to it.

Based on the above broad selection criteria, I have ended up with around 4-5 funds most of the time. After investing with these funds, I tend to check the performance once or twice a year.

24 comments:

Anonymous said...

Hi,
Can you tell us what those 4-5 funds that u have selected finally.

Rohit Chauhan said...

dsp meryll lynch opportunities fund - continue to hold for last 6 years
reliance vision
birla sunlife equity fund
hdfc equity fund
franklin blue chip funds
an index fund and Nifty bees - ETF

abhikush said...

How do you get the data? Is there a website which provides all the parameters you have mentioned?

Rohit Chauhan said...

try http://www.valueresearchonline.com/ to do the initial filtering. for other details go the website of the AMC itself and read their prospectus

i think mutualfundsindia.com is a good website too

Vic said...

Rohit,

which Index fund have you selected?

Thanks,

Vikas

Rohit Chauhan said...

hi vikas
i prefer nifty BEES. They are ETF's with a cost ratio of around 0.8%. Several traditional index funds charge very high fees , upwards of 1%. that in my opionion is ridiculous ..why should one pay for a passive portfolio

regards
rohit

Vic said...

Hi Rohit,

Thanks for your prompt response. I love your articles, new to your blog.

Actually, I have been thinking of adding Nifty BeeS for large cap and Junior for Mid cap exposure but heard these have liquidity issues as not very common in India. Would you be comfortable with investing in both?

Also, do you a post or article where you summarize your stock pics/portfolio etc?

I loved your 4-5 articles related to investing in MFs, best piece of info so far..keep it up!!

thanks much,

Vikas

Vic said...

Also, I noticed Nifty BeeS has an ER of .5% and u mentioned .8%?

Is there any other addional expense? Shouldn't as it is an ETF.

Thanks.

Vic said...

Rohit,

I did some research on Valueresearch and MutualFundsIndia. Only two of your Five diversified Funds show in Top 15 in terms of return (> 5yrs). The return range was 41 - 53%. I know the return is not the only measure but shouldn't all show up in Top 10 or at least in Top 15?
Will it be worth investigating to see how these top 5 picks weathered during this year.

Any change in your recommendation. I'm planning to use your posts in building Stocks and MF portfolio during next few years.

thanks,

Vikas

Rohit Chauhan said...

Hi vikas
i do not recommend stocks or mutuals on my blog. i do the analysis and post them. stock ideas are under the link - investment ideas. however i dont provide any recommendations as such.
i also dont post my portfolio, but do hold several of the stocks i post on my blog

regarding the expense ratio - 0.8% is from memory. if you see 0.5% ..you may be more accurate

which mutual funds are you referring to ? my analysis has been based on the performance of last 10 years. a lot of funds do well in a bull market and then collapse in bear markets.

you are right ..a few of these mutuals may not be among top performers ..but i prefer funds which perform better than an index over a long period of time. however it is possible that they may underperform for long streches too. my performance review is once a year and a few of these funds are underperforming this year. however unless i see poor performance for 1-2 years ,i stick with the funds. it is risky to chase performance on a yearly basis as you may step into a fund just when it has ridden a wave and may be poised to underperform. so preferable to look for funds which have done well for a long period of time

hope this helps

Vic said...

Thanks Rohit, your post helps a lot. I understand your preference for not posting your portfolio or making recommendations.

I did my research for 5 years (max allowded on valueresearch or mfindia). But I do agree with what you said in your post. Will see how your top five MF picks stack up against Top 10/15 over five years..just to get an idea.

But you didn't answer my question on liquidity issues related to Nifty and Junior BeeS.

Like you shared your journey of MF investing over last 10 years, would be nice to hear the same about Stocks too. So that we get to compare it with MFs.

You don't have to post your investments but your experience, valuable learnings..like you did in your MF post.

thanks.

Vikas

Rohit Chauhan said...

Hi vikas
my aim on my blog is to provide approach to selecting stocks or mutual funds. i sometimes list the stocks and mutual funds which i find attractive. however i have refrained from recommending as even
if the approach is same, there are several qualitative reasons and biases for a selection. for ex : some of the mutual funds i hold have done well in a 10 year period. however they have not done well in the last 1-2 years
In the past i would liquidate these mutuals. but i have found that in the long run best of fund provide 4-5% extra returns over the index. they may outperform for 3-4 years and then regress to the mean.
so for me a long operating history and 4-5% outperformance is sufficient. that may not be an ideal criteria but works for me. ofcourse i tend to change my mind when the facts change and do not want some one to be stuck with my recommendations


selecting from top 10 funds in the last 5 years i a good starting point. but always analyse what led to the outperformance and will it happen again in the future ? was it due to some lucky bets ?

on liquidity i do not know. i have never bought midcap bees etc. i have restricted myself to nifty or bse sensex etf generally

i have written on my stock experiences in the past. unfortunately they are not in a single post. i will try to consolidate and provide them in a future post

Rohit Chauhan said...

Hi vikas
my aim on my blog is to provide approach to selecting stocks or mutual funds. i sometimes list the stocks and mutual funds which i find attractive. however i have refrained from recommending as even
if the approach is same, there are several qualitative reasons and biases for a selection. for ex : some of the mutual funds i hold have done well in a 10 year period. however they have not done well in the last 1-2 years
In the past i would liquidate these mutuals. but i have found that in the long run best of fund provide 4-5% extra returns over the index. they may outperform for 3-4 years and then regress to the mean.
so for me a long operating history and 4-5% outperformance is sufficient. that may not be an ideal criteria but works for me. ofcourse i tend to change my mind when the facts change and do not want some one to be stuck with my recommendations


selecting from top 10 funds in the last 5 years i a good starting point. but always analyse what led to the outperformance and will it happen again in the future ? was it due to some lucky bets ?

on liquidity i do not know. i have never bought midcap bees etc. i have restricted myself to nifty or bse sensex etf generally

i have written on my stock experiences in the past. unfortunately they are not in a single post. i will try to consolidate and provide them in a future post

Vic said...

thanks again. I was very impressed with your post on your MF selection criteria. I haven't come across anybody who looks at so many factors (which are really important ones). I loved your MF Investment journey. I can relate to it in some way.
Of course, it is personal for you. But I want to say that it is ok to post personal portfolios/picks, not for others to follow but to take what they need. And of course it has to be supported based on your beliefs, not mere picks. See the following link:
http://www.mymoneyblog.com/my-retirement-investment-portfolio
This guy even posts his Networth. This is a famous Blog in the US (top one as per Money Magazine).

I'm US based, most of my money is in Vanguard and DFA Index Funds, diversified across all asset classes based on my Risk apetite. Since I don't have much time to pick stocks.

Is Blog only way to communicate with you or there's an email that we can reach you at?

thanks again for your reasoning and help. I'll definitely be in touch.

Vikas

Rohit Chauhan said...

Hi vikas
thanks for the comments. you can reach me on rohitc99@indiatimes.com

regards
rohit

Aaradhna said...

Hi ,

Selecting the apt fund plays a very important role.Before investing money its better to analyse several funds and their previous performance. In many websites they have options to view thier different fund performance, from which we can easily figure out the best fund to invest in.

Example : http://www.sundarambnpparibas.in/award/Mutual-Fund-Awards

Regards,
Aaradhna

Rohit Chauhan said...

aaradhna
i would take awards with pinch of salt. i would prefer a mutual fund which has a long operating history and has performed above average in the long run , rather than the shooting stars who do well for short periods and then fizzle out

regards
rohit

Anonymous said...

I live in Singapore, and stumbled across your blog, a good read so far.

I'm amazed at the high expense ratios even for non-managed funds and low AUM, esp those of benchmarkmutualfunds, which make a pretty bad choice.

As more people start doting ETFs, I'm pretty sure expense ratios come down significantly. harsha

arunsg said...

Now there's morningstar site as well. It provides some nice features - a 10 year performance, for example. Also has a "X-ray" feature. If you have a portfolio of funds, morningstar allows you to track the overall portfolio performance, and also stocks overlap & sector allocation.
I've had the FT Bluechip, HDFC equity and HDFCT200 for over 10 years now, and while not spectacular, these funds have consistenly beaten the index over most periods.

ajinkyad said...
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ajinkyad said...
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sri said...

Good research ., Some of the top funds are HDFC top 200 (aggressive) , Hdfc balanced , Fidility equity , Canara robecco tax fund , Hdfc tax saver ..etc Always try to do SIP than putting money fully..
http://sriyahooanswers.blogspot.com

ajinkyad said...

hi rohit, i have read ur posts on MFs..one thing i need to ask abt ur mutual fund portfolio is diversification..i m commenting abt 5 funds u hav selected ( may possible tht u dnt have any positions in them right )
1. all ur funds are large caps nd multicaps..why?
2. dont u believe in core nd satellite approach which many magazines,papers are advocating these days
3. you are an aggressive investor nd ur MF portfolio doesnt reflect tht
4. u hav invested in growth style funds only..nt any value fund why? dont u think diversification in investment style is also necessary
5. i hav read abt MFs on many platforms, aggressive portfolio according to me would be - 1 large cap, 2 multi caps, 1 midcap, 1small cap/ midcap; among these funds min 2 must hav value investing approach..
do u see any flaw in dis strategy? please post ur reply..
because after reading ur posts i hav a feeling dat u cant go wrong on anything! i m quite eager to hear ur opinion on above points..sorry for posting such a long post..

vinbat007 said...

Hi rohit.This is the question I have been pondering upon for a very ling time.Should we select separate funds for large cap,mid cap and small cap or just select few diversified funds.Please answer