Mutual funds are popular investment options. Fund houses pool monies from investors to create a diversified portfolio of stocks, bonds, and other money market investments. Mutual funds can hep you generate higher returns over time. However, several performance factors can have a bearing on mutual funds. Let’s us discuss some of these.
Understanding the factors affecting mutual fund performance
Overview of the mutual fund industry
In India, the mutual fund industry began with the creation of the Unit Trust of India in 1963. The Securities and Exchange Board of India (SEBI) regulates mutual funds. The Association of Mutual Funds in India (AMFI) is the apex body that represents all the registered mutual funds in India.
Types of mutual funds:
- Equity funds: They invest most of the corpus in equities for capital appreciation and a small portion in fixed-income securities to generate a steady income.
- Debt funds: Most investments will be in corporate bonds and government securities for income-generation. Since the equity-component is smaller, there is lesser scope for capital-appreciation and the risk element is minimized.
- Hybrid funds: They are a mix of equity and debt funds catering to different risk-appetites and investment.
- Index funds: Index funds follow market indices like the BSE Sensex and Nifty and try to mimic their performance.
- Sectoral funds: These funds focus on specific sectors like infra or health care. The portfolio focuses on investment opportunities within the sector.
Distribution network: Banks, financial advisors, national distributors and online platforms serve as mutual fund distributors.
Performance: Investors can check the net asset value (NAV) to know the total worth of their portfolio. NAV is calculated by dividing the total market value of the assets by the number of units/shares issued. However, every mutual fund will have also have a benchmark such as the BSE 200 index against which its performance is measured.
Investor-base: Investors are flocking into mutual fund investments, ever-expanding the investor-base.
Here are some economic factors that have a bearing on the performance of mutual funds.
Debt mutual fund: There is a direct impact. As debt funds invest mostly in fixed-income securities, any rise in interest rates leads to a fall in the price of underlying bonds, resulting in a lower NAV. When interest rates fall, the opposite happens.
Equity mutual fund: The impact is not direct. Interest rate-rise results in a higher cost of borrowings for corporates, which could erode their earnings. Conversely, cheaper borrowing costs would help businesses expand.
Hybrid mutual fund: As these are a mix of equity and debt, the impact will depend on the portfolio.
Inflationary impact would depend on the investment strategy and the nature of inflation.
- Returns: If the portfolio consists of assets that appreciate during inflation, the returns will be higher.
- Higher expenses: Inflation increases costs. Also, where the portfolio has more fixed-income securities, the NAV, and its earning-capacity get impacted.
- Volatility: Inflationary trends cause panic in the market leading to an exodus of funds as investors start selling out. This causes asset-prices to fall, leading to a fall in NAV.
- Sectoral preferences: Inflationary trends will benefit sectors that are critical necessities to daily life (like health and utilities), but will hurt consumer discretionary sectors like entertainment and tourism.
Gross domestic product (GDP)
The GDP reflects the market value of all the final goods and services produced within the country during a specific period. The correlation between GDP and mutual funds is not a straightforward one. A rise in GDP generally signals robust economic activity and an increase in corporate earnings and profits. A rise in earnings bodes well for corporates and is generally favorable for equity mutual fund investors. GDP growth could also result in a spurt in consumer spending, thus benefiting such sectors.
Monetary and fiscal policies
Monetary policies: We have already discussed the effects of interest rates and inflation on mutual funds.
Fiscal policies: Fiscal policies refer to stimulus measures rolled out by governments to boost economies during a recession or growth slowdown. Economic growth gets a boost from government spending. However, spending can also trigger inflation which is detrimental to mutual fund returns.
Market-related factors can directly influence the performance of mutual funds.
Stock market performance
When the stock market performs well, the NAVs of mutual funds tend to rise, given their exposure to equities.
Bond market performance
When bond markets perform well, so will the funds investing in fixed-income securities as their NAVs rise.
Commodities market performance
Commodity funds benefit when commodity prices increase. So will equity funds if they have exposure to companies dependent on those commodities.
Foreign exchange rates
When the foreign currency appreciates against the rupee, the returns are higher and vice-versa. However, this applies only if you invest in mutual funds that invest in, say, the US stock market.
Investment objectives and strategies
The investment strategies will be based on the primary objectives of the fund scheme, which could be income generation. Fund managers scout around for undervalued shares in the market, hoping to benefit when their prices rise.
Fund management and expense ratio
The performance of a fund depends on the expertise and the quick responses of fund managers as they buy/sell securities.
The expense ratio is a percentage of the fund’s average NAV. In other words, it is the amount you pay to the asset management company as a fee to manage your investments. The higher these are, the lesser the return will be.
Fund size and asset allocation
Fund size: The greater the AUM, the greater the potential to spread investments and get higher returns. But, sometimes, too large an AUM poses problems when the fund tries to transact large chunks without impacting the market price.
Asset allocation: This is the ratio of funds allocated to different asset classes. This should align with investment objectives.
Fund turnover and trading activity
When turnover is high, and when trading is frequent, the expense ratio also increases because of transaction costs.
Political and regulatory environment
Regulatory changes, tax-policy-changes, and government policy changes impact mutual fund performance.
Natural disasters and geopolitical crises
Natural disasters, a pandemic, or border skirmishes could induce volatility in the market, causing investor panic and depressing asset prices.
Social and demographic trends
Rising standards of living, urbanization, changing demographics, and people becoming more finance-savvy can influence mutual fund performance. Changing social trends where people look beyond land, bank deposits, and jewelry as investment options and ease of investing are other factors.