Choosing A Fund? Look Beyond The Returns

In the ever-changing financial landscape, mutual funds have been playing an increasingly important role in investors’ portfolio. While mutual funds are superior to other investment options in terms of variety, flexibility, transparency and tax efficiency, investors must have a clear understanding of the products. It is equally important to have them in the portfolio in the right proportion to ensure the right balance between risk and reward. For investors, who are new to investing in mutual funds, it can be a little tricky to differentiate between the variety of products. [EasyDNNnews:PaidContentStart]

Although it is relatively easier to differentiate between diversified funds and speciality or sector and thematic funds, it can be challenging to decide between funds wherein the fund manager has the flexibility of deciding exposure to different market segments and the ones where these limits are prescribed by the regulations. It is important to understand that despite having a few similarities, the end results could substantially be different based on which category of funds is included in the portfolio. A couple of such examples are multi-cap and flexi-cap funds as well as index funds and exchange traded funds (ETFs). 

Flexi-Cap versus Multi-Cap Funds
A flexi-cap fund is a fund wherein the fund manager has the flexibility of deciding the allocation to different market segments i.e. Large-Caps, Mid-Caps and Small-Caps based on the emerging economic and market scenario. Most flexi-cap funds usually maintain a bias towards large-caps in the portfolios. However, most fund houses have internal guidelines for fund managers with regard to the maximum exposure they can have in each industry as well as segment. On the other hand, multi-cap funds have to maintain a minimum exposure of 25 per cent to each of the market segments and the remaining 25 per cent can be allocated across different segments. 

This can be done in any proportion as per the fund manager’s discretion. To that extent, an investor retains control over the exposure to each market segment, which is not possible in a flexi-cap fund. As is evident, a minimum exposure level determined by regulations makes multi-cap funds more disciplined. However, the returns can be more erratic when the market turns volatile. That’s because a flexi-cap fund manager may be able to handle the market volatility more efficiently by increasing allocation to large-cap stocks. Of course, this could also result in underperformance during a bull run. 

Index Funds versus ETFs
An index fund is a type of passively managed fund that seeks to track the performance of a benchmark market index like BSE Sensex or S & P CNX Nifty. To achieve this intended result, the fund maintains the portfolio of all the securities in the same proportion as in the benchmark index. The offer document of an index fund clearly states as to which index the fund would track. The major advantage of investing in an index fund is that one knows exactly the shares the fund would invest in. 

Besides, for an individual investor, it is practically impossible to create a portfolio that matches an index fund portfolio. The downside of investing in an index fund is that one forfeits the possibilities of earning above-average returns that a good quality diversified fund may be able to provide over the longer term. An exchange traded fund (ETF) is a hybrid product that combines the features of an index fund as well as stocks. 

ETFs can be bought and sold like any other stock on an exchange through a dematerialisation account during market hours at prices that are expected to be closer to the NAV at the end of the day. Therefore, one can invest at real-time prices as against the end of the day prices as is the case in open-ended schemes. For investors who don’t usually invest in an account, opening a dematerialisation account for investing in ETFs alone can be a costly affair. Index funds can be a better option for them. 

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