When you hold mutual funds you would know that each mutual fund also has a portfolio behind it. This portfolio disclosure is mandatory for mutual funds but for investors and unit holders it is a wealth of information that can give you important clues about how the fund is performing, how it is structured and what are its key constituents? As mutual fund investors, there is critical information that you need to focus on. A little bit of effort can give you invaluable inputs about your fund and its management.
The portfolio mix of equity funds…
This is the most important thing you look at when you look at equity funds. What are the stocks they hold in their portfolio? Most mutual funds also disclose what are the changes in their portfolio? Try to understand whether these changes are in tune with the broad trends in the market. Let us take an example. You know that oil prices are falling and oil stocks have been doing badly in the market. You surely want to know why your mutual fund is adding oil stocks to its portfolio. Your fund manager may have a valid reason but you surely need to ask that question.
It is very important to look at sectoral exposure of your equity funds. For a large equity diversified fund you can safely assume that the sectoral mix will be broadly in line with the Nifty or the Sensex. That means Banks and IT would dominate the portfolio; and that is understandable. But if your fund portfolio is largely skewed towards FMCG or metals, you surely need to know why the portfolio is not in tune with the index average.
What to look for in a mid cap fund…
A mid cap fund is a slightly different type of a ball game. For example, in a large cap fund, the sectoral mix can mirror the Nifty or Sensex. But that cannot be the case in mid cap funds. Mid cap funds must have lower exposure to specific sectors. Thus if a large cap equity fund has its largest exposure at 28%, then a mid cap fund should ideally not be more than 12-13%. Also ensure that your mid cap fund is not overly focused on a handful of companies or a few business groups. This exposes your fund to the vagaries of a few business houses and increases your risk. You need to be watchful of that.
In case of equity funds, you also need to look at portfolio turnover ratios. These are disclosed by most funds in percentage terms. Equity funds can have a portfolio of between 30-50% which is acceptable on an annualized basis. After all, mutual funds are long term investments and you do not want your manager to pay the broker more than the unit holders.
What to look for in an index fund…
Of course, the first thing you look for in an index fund is whether the portfolio mirrors the overall index or not. Most index funds tend to mirror the Nifty or the Sensex but there are fund managers who try to tweak the portfolio mix to earn that additional alpha. Remember, that is not the job of an index fund manager. You are not invested in an index fund to take the manager’s discretion risk. You can do that by investing in a diversified equity fund or a mid cap fund.
Most index funds also disclose the tracking error. For an index fund, the lower the tracking error the better! It is a statistical indicator of how closely the fund mirrors the index.
What to look for in an arbitrage fund
Arbitrage funds typically focus on cash-futures spread. They buy in the cash market and sell in futures market to earn the spread. There are a few critical things you need to look at when evaluating the portfolio of an arbitrage fund.
Firstly, is the portfolio skewed in favour of penny stocks? Such stocks may give higher arbitrage spreads but the risk is also very high. Be cautious in such cases. Secondly, look at the value of the equity portfolio and value of the short futures. They will be approximately equal, which is normal. This data point underlines if the fund manager is trying to punt for that extra alpha. Last, but not the least, compare the returns of an arbitrage fund with that of an FD. As long as arbitrage funds are returning a spread above the FD, they are good investments, not otherwise.
What to look for in a debt fund…
Debt funds typically invest in debt instruments issued by the government and by private entities. There are quite a few key things to note in a debt fund portfolio. Ensure that your debt fund is not over exposed to the debt of a single company or group. We saw the risks of that in the J P Morgan Mutual Fund case where they had to almost freeze redemptions due to their inordinately high exposure to Amtek Auto. Look at the duration of the portfolio. You want to be in a long duration portfolio in a falling interest rate scenario for sure. Lastly, look at the proportion of AAA and AA rated debt. It will give you the trend; whether your fund manager is trying to go down the rating curve to earn higher returns.
In a nutshell, mutual funds portfolios are a storehouse of valuable information. As a smart investor it is for you to glean as much of wisdom as possible. At least, you can make a start!
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