Mutual Fund

What is a mutual fund?

A mutual fund is a pool of money managed by professional investors, The money comes from retail investors(average person), institutional investors(large corporations, Big investors), Government, etc. What happens is when you buy a mutual fund let's say for 10000rs what the mutual fund managers will do, They evenly distribute money and do daily operations of buying and selling on your behalf, The growth rate of the fund shows how much profit a fund has generated.

To understand their role and functioning in the financial market we must dive into the history of the mutual fund.

The first modern mutual funds were established in the Dutch Republic. In response to the financial crisis, of 1772–1773, Amsterdam-based businessman Abraham (or Adriaan) van Ketwich formed a trust named Dragnet Markkaa Magt ("unity creates strength"). He aimed to provide small investors with an opportunity to diversify. Ever since the dawn of financial markets, the retail investor wealth was always under a threat because there were no regulatory agencies or future and options contract to hedge their risk(if you don't know what is future and option then don't worry I will be explaining them in future articles). After the crisis of 1772-1773 people were reluctant of investing in stocks and they had a good reason for that because their entire wealth has been evaporated so some clever minds who understood the market better than layman they started a new service under which they will buy on behalf of investors and they will have full authority to buy and sell these stocks.

Advantages

• Increased diversification
• Daily liquidity
• professional investment management
• Convenient
• Transparent operations

Disadvantages 

• Fees for managers.
• Less control 
• less predictable income

Retail investors trusted these professionals and started earning stable returns which were always better than earning unusual returns. Over the years many forms of mutual funds have been introduced which are as follows.

• Equity mutual fund
• Hybrid mutual fund
• Debt mutual fund
• Index mutual fund

1. Equity mutual fund is simple when buying and selling take place on in the equity market
2. A hybrid fund is diversified where buying and selling takes place of many segments such as bonds, index, etc
3. Debt mutual fund is invested in the derivative market.
4. An index is simple it invested in many indexes such as Sensex, nifty 50, nifty auto, etc

   

   
   

Now let us come to the most important part of how to select a perfect mutual fund, Given the fact that only 6 out of 192 mutual funds give a double-digit return one must analyze these three parameters to select a good mutual fund.

1. Expense ratio
2. Risk-adjusted return 
3. Portfolio turnover.

• The expense ratio is very simple and a very useful tool to select a mutual fund, let us assume a fund is giving a return of 12% but it's not the amount of profit an investor is going to receive. when we deduct all the expenses of the mutual fund we get net asset value(NAV) and if expenses are 3% the NAV is 9%, Hence high expense ratio means lower returns so always compare the expense ratio before selecting a mutual fund.
• Risk-adjusted return reflects the quantum of risk taken by the fund to earn a return, This will tell you how much risk-free your fund is, there are many simple methods to do that which are Alpha, beta, R squared, standard deviation, and Sharpe ratio.

1. Alpha shows us how much our fund has gained more by the index, Suppose Sensex gains by 4% per annum and our fund increases 12% then alpha is 8% per annum.
2. Beta measures the systematic risk, which means how much risk is being taken by the fund manager.
3. R squared is a form of benchmark because it compares the fund's movement with index movements. Let assume that Sensex falls 2% and our fund falls 1% that means r squired is 50%. It represents how much impact an index has on our fund.
4. Standard deviation might sound difficult but its the most simple tool, for example, you compare 5 funds and find out the mean value then look at the difference of the dataset from its mean is the standard deviation.
5. .Sharpe ratio is quite technical i might write it in the future because it is used by investors who invest in multiple funds.

• The last thing is portfolio turnover ratio is the churn(salary of the manager,staff,etc)in the mutual fund the manager has made.A high portfolio turnover means higher costs for investors.

I hope you learn some new things after reading this blog and if you want to invest or trade in the stock market please contact me I am a sub-broker at angel broking.