Good and bad performance can evoke mixed reactions

Every investor who invests in mutual funds wants his funds to do well. However, not many know how to evaluate the performance. Besides, even when the portfolio does well, different investors react differently to that situa-tion. Here are some of the situations that investors face from time to time and how these need to be tackled:

‘Good performance’ is a subjective thing. Ideally, to analyse performance, one should consider returns as well as the risk taken to achieve those returns. Besides, consistency in terms of performance as well as portfolio selection is another factor that should be considered while analyzing the performance. Therefore, while evaluating the performance of a fund, it is necessary to analyse the factors such as risk taken by the fund manager and whether he gave an adequate reward for taking that risk. It is equally important to consider whether the revised level of risk is in line with one’s own risk profile.

The right way to evaluate the performance of a fund The following factors are important in evaluating the performance of a fund:

•One needs to consider long-term performance rather than short-term performance. Because long-term performance track record moderates the effects which unusually good or bad short-term performance can have on a fund’s track record. Besides, longer term performance compensates for the effects of a fund manager’s particular investment style

•Evaluate the performance against the peer group. While measuring performance against the benchmark is important, the comparison with the peer group provides the right measure of a fund’s performance.

•Discipline in the investment approach is an important factor as the pressure to perform can make a fund manager susceptible to have an urge to change tracks in terms of stock selection as well as investment strategy.The objective should be to differentiate investment skill of the fund manager from luck and to analyse the likelihood of future success.

Negative returns from a fund do not necessarily mean poor performance. Even the best of fund managers are likely to give negative returns during periods where markets go down significantly. Besides, the time period considered also signifies the true level of performance. For example, short-term negative returns, in line with the market, from a fund that has been doing well for years, means nothing and should be ignored.

Similarly, even a bad fund manager can give decent returns when the markets are doing well. Besides, a fund manager can enhance the returns of a fund in a good market by increasing the risk exposure. Therefore, one needs to go beyond the performance numbers to judge the skill of a fund manager.

This is a dilemma that most investors face when the mar-ket is in a bull phase and as a result funds perform very well. In times like these, investors often forget about the original mix of equity and debt and as a result make their portfolio very risky. No doubt, equity market requires a long-term commitment to benefit from it; however, it is equally impor-tant to rebalance the portfolio to bring the asset allocation closer to the original levels. This is the most logical way to book profits in a bull market and invest more money when the markets are down.

However, rebalancing of the portfolio also requires a proper strategy. While doing so, one must consider factors such as tax implications and exit loads (if any). Besides, one must first exit from the non-performing funds rather than exiting from better performing ones. It is also important to keep a close watch on the performance of sector funds, if one has them in the portfolio, as they are cyclic in nature.