4. Risk

Returns are important, but risk is just as important, if not more.

Risk can be quantified in various ways from as simple as standard deviation and beta to more complicated risk models. What is important to check is a fund doesn't just show good returns, but good risk adjusted returns. Sharpe or information ratio is a good measure of risk-adjusted returns.

In addition to total returns, the risk a fund takes relative to its benchmark should be studied. If you are looking for equity returns similar to the benchmark and a fund is taking a lot of risk to the benchmark, you may not be paying for what you want.

Also, good funds should have an independent risk management team that oversees the portfolio manager and keeps the risk the manager takes in check.

3. Investment style and process

A good fund manager will have a distinct investment style, whether it is fundamental, quantitative or macroeconomic. No one style is better than the other; the important thing is whether the manager sticks to her/his investment style and if this style is reflected in the portfolio holdings. A small-cap fund manager should not start doing arbitrage strategies just because they get good returns.

A fundamental manager who focuses on the deep understanding of companies and sectors should not manage an IT fund, a pharma fund, and an infra fund. A fund manager's style should not be determined by what is selling in the market.

2. Fund manager profile

The fund manager (not the fund) is often ignored in the mutual fund decision-making process, and is more directly related to how your money is managed than the fund house. In reality, the fund manager is the one making the actual investment decisions and driving the trades.

A strong fund manager will have a professional qualification in finance and many years of experience in investment management, where investment management is specifically the management of funds, and not investment banking, chartered accountancy, and brokerage.

Understand what funds the manager has worked at in the past and what her/his own investment track record is. It's also important to look at the management of the firm and their involvement in the fund: Who makes the final decision, the fund manager or the fund house management?

10 ways to evaluate a mutual fund (1)

Every mutual fund agent and financial Web site has different theories on how to evaluate mutual funds. Many of these theories focus on simply analyzing the fund's recent performance and the reputation of the fund house, which is rarely enough to differentiate a good investment from a bad one.

In reality, mutual fund analysis is a sophisticated problem studied by global investment professionals, and while no list can do complete justice to the problem, there are ten nuanced factors that professionals look at:

1. Performance track record

Everyone scrutinizes returns but the key word is track record or the complete history of returns. Funds in India often sell on recent track record (a week, month, or year), which says little about the fund's long-term performance. Fund houses will also cherry pick the period of returns they show to make the fund house look good.

Since inception performance or performance over the fund's life is a critical factor, equally critical is what the starting point for the fund was. An equity fund that started in October 2008, a market low, will have great since-inception performance today, because it happened to catch a big bull market.

Everyone can succeed in a bull market; analyses how funds have performed in a bear market. Be sure to use a correct benchmark when analyzing a fund's relative performance. A small-cap fund should be benchmarked to an index like the BSE 200 or BSE 500, while a large cap fund to the Nifty or Sensex.

Fund houses will commonly show small-cap funds in comparison to the Sensex, which is an unfair benchmark because there is a premium on small-cap stocks as they always do better in a broad based bull rally.