How To Judge A Mutual Fund
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Equity mutual funds are an alternative to individual stocks. They are an easy way to participate in the stock market. They enable the investor to diversity risk and obtain professional management.
Key question: How do you choose the right equity mutual fund out of the handful available? How do you know what kind of risk you are taking?
To choose a mutual fund:
Determine your goals. Decide if you are in for the short term (a year or two, because you would like to make a profit and buy a house) or for the longer term (awaiting retirement).
Use comparative mutual fund listings to identify which funds have performed best over the past 5-, 3- and 1-year periods. The tables make it simple to pick out the mutual funds that have performed best.
Research the performance of the best mutual funds by comparing an individual fund's performance for the past years with the performance of the Philippine Stock Exchange Index for those years. Example: If the PSE is up 20% and the mutual fund is up 50%, the fund is likely to do well in an up market. (Its record should be fairly consistent and its management stable). If the PSE in a number of years is down, and the mutual fund is down much more, it usually means the fund is a high risk in a down market.
For a long-term investment in a mutual fund: Look at the record of the funds that have done well in up markets and have conserved their capital in down markets. Choose good performers that went down no more than the PSE in poor years.
Load versus no-load: Load mutual funds charge a sales commission up to 3% when you purchase them. No-loads do not. Both charge management fees. No-loads are attracting most of the money these days. The record shows no performance difference between the two.
Management: Look for a mutual fund with consistent management. A parent company that is financially strong can attract better managers and has the ability to keep them. Make sure the fund's manager is the same one who was with the fund last year and the year before, assuming the record is good.
Look at a mutual fund with a family. It may be convenient to use a mutual fund that has other types of funds in-house. Examples: Balanced mutual funds, bond mutual funds, money-market funds. Reason: An investor doesn't know where the stock market, bond market, or money market will be five years from now. Although you can always switch funds on your own, it's more convenient to switch by just making a telephone call.
Look at the total net assets of the mutual fund. It may be a factor in profitability. Smaller mutual funds are likely to outperform large ones. Reason: If managers have a large amount of money to invest, they are not going to take a position in a small company even if it is a very attractive one. Why? Tracking it is too time consuming and will not be significant in the fund's earnings. Also, if a company turns sour, it's hard for a large mutual fund to sell so much stock quickly without forcing down the price.
Watch the redemption rate of the mutual funds. That's the rate at which people are withdrawing their money. Reason to keep alert: If a mutual fund is having massive redemptions, its management is having problems. Worse: The mutual fund now is being forced to liquidate positions for cash to meet redemptions, which complicates its problems.
Mutual funds where there are huge fluctuations of assets may signal a problem. They may be flooded with money at times by pension-fund managers and overseas money managers who play the stock market through no-load mutual funds. Trap: When the mutual fund manager has to redeem these positions quickly, it will hurt the performance of the mutual fund, and therefore your investment.
Adapted from: The Book of Inside Information, based on Stanley Egener, executive vice-president, Neuberger Berman Management Co., Inc.« Read Previous Article Read Next Article »