How is the Consistency of an Equity Mutual Fund Scheme Measured?

21 April, 2025

Synopsis:
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• Evaluating mutual fund consistency enables investors to make well-informed choices. Historical numbers are insufficient to forecast future outcomes, so the preferred option is a fund delivering consistent returns.

• The fund's stability becomes measurable through quantitative factors, including CAGR, historical performance and benchmark comparison, Sharpe Ratio and Sortino Ratio, Standard Deviation and Rolling Returns, and the Upside and Downside Capture Ratio.

• Mutual fund consistency depends on qualitative elements (fund management skills, portfolio distribution, expense costs, and ratings in specific fund categories) and quantitative indicators (portfolio expertise and investment diversity). 

• By analysing quantitative and qualitative factors, investors can make better future investment decisions.
  
  

You must have heard the classic story of the rabbit and tortoise, which teaches that a slow and steady wins the race. So here tortoise won the race against a faster rabbit who runs fast and takes a nap halfway. Similarly, investors should measure their portfolio performance if they want a consistent portfolio return. Investors can use quantitative and qualitative measures to determine the fund's consistent performance.

1. Quantitative Factors

There are some key factors to measure the consistency of mutual funds, which this section details:

1. CAGR (Compound Annual Growth Rate)

Investors should check the CAGR of the funds. This measure measures the annualised growth of a mutual fund over a specific period and provides an accurate representation of its performance.

2. Historical Performance Trends

Periods spanning three, five, and ten years allow investors to view the overall return consistency of mutual funds. Financial security requires a consistent fund that maintains steady returns irrespective of the stage of the market. The past historical performance serves as valuable information but should not be an absolute indicator because market conditions are predicted to change.

3. Benchmark and Peer Group Comparison

To check the consistency of a fund's performance, investors can compare its performance against their benchmark index, such as Nifty 50 and S&P BSE 500, and should compare its performance with peer groups. If the fund's performance is above the benchmark, it indicates a good investment.

4. Risk-Adjusted Return Indicators

• Sharpe Ratio: This ratio compares an investment's returns with its risk. Investments with higher Sharpe ratios demonstrate better surplus returns about associated risks.

• Sortino Ratio: This ratio explicitly examines downside risk, making it suitable for evaluating conservative funds in declining markets.

• Standard Deviation: Measures the volatility of a fund's returns. The extent of volatility in an asset can be measured through standard deviation statistics because high numbers show more volatility, whereas low numbers demonstrate consistency.
  
  

5. Rolling Returns for Long-Term Stability

Investors can analyse the fund's performance through rolling returns as it calculates multiple period evaluations, which span consecutive segments of daily and monthly data. Rolling returns help remove the point-to-point return bias and provide an improved understanding of the fund's performance consistency.

6. Upside and Downside Capture Ratios

Upside Capture Ratio helps determine how much a fund's performance rose above its benchmark indices during boom market conditions. Conversely, the Downside Capture Ratio is an evaluation tool that shows how much a fund loses its value during bear market conditions. A high Upside and low Downside Capture Ratio is an ideal condition for reliable mutual funds.

2. Qualitative Factors

The consistency of a mutual fund can also be measured through qualitative factors. Some of them are discussed below:

1. Fund Management and Investment Approach

Investors can analyse the fund's performance through rolling returns as it calculates multiple period evaluations, which span consecutive segments of daily and monthly data. Rolling returns help remove the point-to-point return bias and provide an improved understanding of the fund's performance consistency.

2. Portfolio Diversification and Asset Allocation

Investors who spread their investments between different asset classes and sectors simultaneously reduce risk while increasing their portfolio's stability. Strategically putting all investments into a solitary stock or business segment results in extreme market swings.

3. Expense Ratio and Fund Size

When its expense ratio rises, a fund's ability to generate long-term results decreases. A large fund is an obstacle to making quick decisions, affecting investment returns.

4. Consistency of Fund Ratings and Category Rankings

Investors can expect consistent performance from a fund that maintains top-position rankings within its category. Investors' evaluation of short-term rankings needs to be supplemented by examining long-term performance trends.

Mutual fund investment success depends heavily on the stability of their performance metrics to develop long-term financial wealth. The stability is produced through quantitative metrics like CAGR, rolling returns, Standard Deviation, and the Sharpe Ratio. For optimum understanding, fund management needs to be assessed qualitatively alongside strategy.

Seeking funds that consistently perform? You can check your fund’s performance and make informed investment decisions through the HDFC Bank SmartWealth App. Experience financial growth by downloading this app right away!

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