When investing in mutual funds, you should consider the following factors that can impact the performance of the mutual funds in your portfolio:
Performance of underlying securities
Mutual funds invest in a range of asset classes like stocks, bonds, gold, and money market instruments. This asset allocation has an impact on the fund’s performance. In simple words, if the underlying assets of a mutual fund scheme perform well, the fund’s value appreciates, resulting in higher returns for investors. However, if the underlying assets perform poorly, the fund offers poor returns. Performance of the underlying assets may be impacted by various factors like changes in the structure of the companies, interest rate fluctuations, etc.
Fund manager’s managerial skills
Another important factor that affects the performance of mutual funds is the performance of the fund manager. Each mutual fund scheme is overseen and managed by an experienced fund manager. The fund manager is responsible for managing the asset allocation of the fund depending on its investment objective. Therefore, the performance of any mutual fund scheme is closely interlinked to how well its fund manager can handle the fund. As the market changes, fund managers must regularly assess and analyse their portfolio to make required corrections. A skilled fund manager can navigate complex market fluctuations and still manage to protect the investor’s corpus.
Sector/industry-specific shifts
Sector-specific shifts can significantly affect the performance of mutual fund investments as funds often invest in securities belonging to particular sectors. Changes in regulatory policies, technological advancements, and economic trends can impact the growth prospects of a particular sector. For instance, if the government tightens privacy policies pertaining to the technology industry, funds that invest heavily in tech stocks may experience a decline in returns. However, in the event of a favourable trend like launching of a novel technology can boost the performance of the same fund. As an investor, you should be aware of such factors that affect the performance of mutual funds and thereby, your total returns.
Also read: What Is Compound Annual Growth Rate (CAGR)
Fund size
While this factor is often overlooked, fund size is indeed a crucial factor that affects the performance of mutual funds. As the fund’s size grows, the fund manager’s responsibilities also grow. Larger funds are often more difficult to manage and consequently have limited agility when it comes to responding to market opportunities. The logic is simple: when the fund grows beyond a certain threshold, managing large volumes of assets efficiently becomes challenging. This can potentially impact your returns.
Cash flows of the fund
The cash flow of a mutual fund can also influence its performance. Cash inflows happen when investors want to invest in the fund, while outflows happen when investors want to redeem their investment and exit the scheme. Large inflows offer fund managers more capital to invest, while large outflows force them to sell assets to meet the redemption requests. Often, fund managers may have to sell assets at unfavourable prices to meet the heightened redemption demand, affecting the performance of the mutual fund.
Expense ratio
Expense ratio is the annual fees charged by the AMC to manage your investment. This fee covers the fund’s management expenses, administrative charges, and operational costs. A high expense ratio directly lowers your total returns from the investment as more of the fund’s profits are directed towards meeting these expenses. Alternatively, a lower expense ratio boosts the fund’s return potential. Therefore, you should carefully evaluate this factor before selecting a mutual fund.