In the September 2015 issue of Mutual Fund Insight Value Research carried out an analysis of 20-year old mutual funds and admitted that one of the lessons is to not look for category toppers. This and other nuggets from that issue.
I had a lot of time to kill yesterday at the Bangalore airport after the DIY investor work and got hold of the latest Mutual Fund insight.
The cover story is, "Lessons from 20-year survivors". Five lessons were listed.
- Fund selection matters - which is nonsense as most of the duds were index funds and outright crappy funds which an sane person would have exited upon periodic review. As shown before and as discussed at the investor workshops, mutual fund selection does not matter. Disciplined investing combined with patience and a clearly defined review process is all that is needed. A well-defined selection process is also necessary, but there is no need act like it is rocket science (see below)
More risk (in particular more of mid and small cap funds) does not guarantee more returns- agreed.
"Don't look for category toppers. Look for benchmark beaters. None of the 20-year toppers were the top ranking funds in their categories year after year. In fact, they were only top-quartile or mid-quartile funds. But they did manage to consistently beat their benchmarks whether in good years or bad ones (not each year!)".
That is Value Research basically telling you not to look for top ranked funds! Or in other words, "do not chase 5-star funds". This is a point made here repeatedly:
4. Look for funds that do well in bear markets - Makes sense but not in they way they put it. I would prefer to focus on consistent downside protection.
"If your fund manager manages to keep up with the index in a bear market, be content with the returns .."
While that is indeed sane advice (and something I have gone through), the VR ratings system will automatically downgrade such funds, leading to a lot of confusion and debate - should I exit Top 200, HDFC Equity etc.
5. Funds with a clearly defined mandate are winners - no debate here.
Moral of the story: Use Value Research for data and do your own analysis.
Fund selection criterion: Consistent performance (for a start) combined with consistent downside protection (when the investor understands the concept) is all that is required.
Here are some simple steps to build and review a mutual fund portfolio:
Ignore star ratings
Choose funds which have consistently beat the category average for the past 5+ years using the Automated Mutual Fund Screener - a reasonable metric for consistency.
If you are uncomfortable with equity, choose a single large cap fund, invest a sum and watch it fluctuate for a couple months on daily basis. Imagine what will happen with the investment amount gets larger with a visual aid if necessary: Visualizing the growth of an equity portfolio as a tilted pendulum
Once you are comfortable, You can start a SIP, if you like. Unless we take losses into our stride and realize that they are necessary in order to gain, we cannot be successful equity investors.
Then, after say 6-12 months, you can add one more fund, say a mid and small-cap fund - not more than 40% overall exposure.
If you are not confident with fund selection, choose Turnkey mutual fund solutions to beat inflation
Do not look at the fund performance for at least 3-5 years (the assumption here is that your goal is more than 10 years away).
Then focus on the net return (XIRR) of your equity portfolio (that is both funds combined). Use that as a metric to figure out performance with respect to expectations. More on this here: How to review a mutual fund portfolio and here When should I exit an equity mutual fund?