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.