Why it is important to look at the Underlying Asset Quality and a Fund Manager’s Investing Style??
We’ve a method of fundamental analysis to ascertain quality of stocks based on their ‘10-Year performance on key parameters’ (Green-Orange-Red) and ‘market-capitalisation risk’ (Large-Mid-Small). If the Fund is holding a lot of Red stocks, it means it’s taking high risks. If the fund holds more mid and small stocks with respect to the Benchmark Index, then the Fund may be taking higher risk than its stated objective. In such cases, the Fund’s performance should compensate such high risks accordingly (i.e. high risks-high returns.)
So, the Underlying Asset Quality highlights the amount of risks taken by the Fund Manager to generate returns. When looked at over years, it gives a fair idea of the Fund Manager’s investing style. To know if the Fund is ‘Aapke liye Sahi’, it’s good to check, if the Fund Manager’s style complements your investing style.
How can one know if the Fund Returns will be much different than the Benchmark returns or not?
Comparing the top 10% holding of a Fund and its Benchmark Index gives a fair idea if the Fund Returns will or will not be much different than the Benchmark Returns. Active Share is the percentage of stocks in a Fund that is different from the Benchmark Index. Mutual Funds with high Active Share are likely to generate better returns and lower the risk
However, some Funds closely mimic the holdings of their Benchmark Indices to generate at-least Benchmark Returns. For such Funds, the Fund returns may not be much different than Benchmark returns, and Investors lose a chance to compound their money at rates better than the Benchmark Index. This doesn’t justify the Expense Ratio that such Funds charge. Therefore, it’s better to avoid Funds with low Active Share and rather invest in its Benchmark Index Fund.
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