With the plethora of schemes to choose from, the retail investor faces problem in selecting funds. Worldwide, good mutual fund companies over are known by their AMCs and this fame is directly linked to their superior stock selection skills. For mutual funds to grow there must be some performance indicator that will reveal the quality of selection of various AMCs.
While searching and selecting the mutual funds, the investor should also take into account both the quantitative and qualitative aspects, although the qualitative side is important, an investment consultant will ultimately use same quantitative measure such as ratio, statistics or risk adjusted measure of performance to validate the qualitative component of search and selection.
Factors such as investment strategy and management style are qualitative, but the funds record is an important indicator too. Though past performance alone cannot be indicator of future performance, it is, frankly, the only quantitative tool to adjudge how good a fund is at present.
However, return alone cannot serve as the sole criteria of being the measurement of performance of a mutual fund scheme; it is equally important to consider the risk taken by fund manager to measure whether the risk taken have paid off adequately or not.
Risks associated with a fund:
The risks associated with a fund could be defined based on the fluctuations of the returns generated by it. The higher the fluctuations in returns, in a given period, the higher the risks associated with it. These fluctuations are results of two forces:
i. General market fluctuations, which affects all the stocks in the market. This can be called as market risk or systematic risk.
ii. Risks associated with the stocks in the portfolio of a fund. This is called unsystematic risk.
A fund manager could reduce the unsystematic risk by diversifying the investments. Systematic risks, on the other hand, cannot be reduced and is dependent on the macro economic factors.