How does one evaluate the performance of a mutual fund? Is the appreciation in its NAV the only factor? Can the NAV be manipulated by the fund manager and the AMC? After what time-frame should one consider exiting a mutual fund, if its performance is not up to the mark?

Geeta A. Rao

There are several sophisticated measures available to evaluate fund performance, some of which try to capture the quantum of risk that the fund has assumed to earn its returns. For the lay investor, the absolute return computed on a fund's NAV, after factoring in dividends and bonus units, is a good enough measure of its performance. This is especially true if you have a fund's long term track record.

A lay investor is focused on terminal wealth — the wealth generated by a fund over his holding period; the absolute NAV-based return appears to be the best way to capture this. Since mutual funds offer to encash units at the NAV (or at a small discount to it, if there is an exit load), the return on the NAV is the best measure of the actual wealth generated by a fund you hold. If you hold a fund for the long term, parameters such as the volatility in NAV, portfolio and concentration risk may not be as material as the absolute value of your holdings at the time of your exit.

When making comparisons between funds, however, looking at risk-adjusted returns may be the best way to arrive at a decision. A simple way to evaluate the volatility in returns would be to look at the swings in the fund's NAV from month to month, or how it fared in a bearish or declining market.

It is extremely difficult for the fund managers or the AMC to "manipulate" NAV numbers, because the NAV is based on a standard formula stipulated by SEBI that is followed by all funds. Since SEBI rules require most fund investments to be marked-to-market, the NAV represents the prevailing market value of the fund's holdings.

The NAV number can only be "manipulated" if some of the securities in the portfolio are not traded or are infrequently traded in the market. This is quite difficult in an equity fund, because funds seldom hold illiquid securities. Again, there are SEBI restrictions on how much of a fund's portfolio can be invested in illiquid and infrequently traded securities.

In any case, since an open-end fund allows you to encash your units at any time at an NAV-related price, you needn't worry about whether the NAV accurately captures the value of the fund's holdings. The returns based on the NAV would be pretty close to the returns that you would make if you redeem your fund holdings on that particular date.

Coming to your final query, we think that a fund can be tagged as an under-performer only if it lags its benchmark for at least a year. Exiting a fund because it trailed its peers in a particular three-month or six-month period can inflict serious damage to your portfolio. Before deciding that your fund is a laggard, you also have to make sure that you have compared it with the right competing products.

That means comparing a diversified equity fund with another diversified equity fund and a theme fund with another that has an identical theme. You also need to have the market-cap orientation of a fund in mind, before you make comparisons. A fund that invests mainly in bluechip stocks may make lower returns, but entail lower risk than one that packs its portfolio with mid-cap stocks.

(Queries may be e-mailed to mf@thehindu.co.in, or sent by post to Business Line, 859- 860, Anna Salai, Chennai 600002.)

Aarati Krishnan

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