How to Select Best Mutual Fund in a Particular Category 

Selecting the right mutual fund within a specific category goes beyond merely comparing returns. While many schemes may appear similar, they can differ significantly in terms of performance, risk, and investment approach. Therefore, to choose the best mutual fund in a particular category, it is essential to consider several key factors. In this guide, we will explore a practical method that enables you to compare the available options more effectively.

Start With the Exact Category You Want to Invest In 

Before selecting the best mutual fund in a particular category, ensure that you are comparing funds within the same category. Each category has a distinct investment objective and portfolio structure; therefore, directly comparing returns across different categories is not appropriate. SEBI's current framework standardizes fund categories and their characteristics.

For example, if you have decided to invest in a Mid-Cap Fund, shortlist other Mid-Cap Funds instead of comparing it with Large-Cap or Small-Cap funds. Subsequently, make sure to check the scheme's category, investment objective, asset allocation, and benchmark.

Create a Shortlist Instead of Comparing Every Fund 

Instead of analyzing every fund within a category, shortlisting a few strong options first makes the comparison process easier and more practical.

Create a Shortlist of 3-5 Funds

If a category contains 10-15 or more schemes, it is not necessary to study each one in detail. Begin by selecting 3-5 funds that have a solid track record and for which key details such as performance, portfolio, benchmark, AUM, and risk-related information are readily available in the latest factsheet. According to AMFI, the fund factsheet serves as a useful starting point for evaluating a scheme.

Do Not Choose a Fund Based Solely on Popularity

A large AUM or high popularity does not, in itself, prove that a fund is the best in its category; consider these merely as supporting factors. Base your actual comparison on performance, portfolio, and investment approach.

A Simple Shortlist Example

Suppose you have selected the Flexi Cap Fund category, and there are 12 schemes available. You can shortlist 3-5 funds first and then conduct a detailed comparison of only those selected funds.

Compare Returns Across Multiple Time Periods

Instead of choosing a fund based solely on one-year returns, it is more useful to look at its consistency across different time periods.

Do not base your decision solely on 1-year returns.

While 1-year returns give you an idea of ??recent performance, they do not reveal how the fund has performed under varying market conditions. Therefore, consider 3-year and 5-year returns alongside the 1-year figures. AMFI also recommends reviewing performance across different timeframes—such as 1, 3, and 5 years in fund factsheets.

Good returns over a single period are not enough.

Suppose the performance of two funds is as follows

Understand Consistency through Rolling Returns

Rolling returns show a fund's performance over identical investment periods starting on different dates. This reduces reliance on results based on a single starting date and allows for a better understanding of consistency.

Check Whether the Fund Has Beaten Its Benchmark Consistently 

It is not enough to simply look at the return a fund has generated. It is also essential to consider the return delivered by its benchmark during the same period and how the fund performed in comparison. According to SEBI, a scheme's benchmark should align with its investment objective, asset allocation, and strategy.

Compare the Fund and the Benchmark

Suppose a fund has delivered a 5-year return of 14.2%. At first glance, this might seem impressive; however, if its benchmark has yielded 15% over the same period, the picture changes.

Look at the performance pattern rather than just a single good period

If a fund has outperformed its benchmark in one year but consistently lagged behind in several other periods, that single year of outperformance should not be given too much weight. Instead, look at how the fund has performed against the benchmark across various market conditions.

Adopt a different approach for passive funds

The objective of an index fund or ETF is not to beat the benchmark but to track it closely. Therefore, metrics such as tracking difference and tracking error become more relevant for such funds.

Find Out How Much Risk the Fund Took to Earn Those Returns 

Looking at the return alone is not enough; it is also important to understand the level of volatility with which the fund generated that return.

Look at downside performance.

Maximum drawdown can be useful for understanding how much the fund lost during a market decline.

In this example, both funds offer the same return, but Fund A experienced a smaller decline. If other factors are comparable, Fund A might be a more comfortable choice for a risk-averse investor.

Align Risk with Your Capacity

If you can stay invested even when the market falls, you can manage higher volatility. However, if you are likely to sell upon seeing a significant drop, it may be better to avoid a more aggressive fund.

Look Inside the Portfolio Before Making the Final Choice 

After examining the fund's category and past performance, the next crucial step is to understand the portfolio. After all, the specific companies and sectors where your money is invested reveal the fund's actual exposure.

View Top Holdings

Check the fund's largest holdings in the latest portfolio. If there is a very large allocation to a single company, the performance of that stock could significantly impact the fund's overall return.

Focus on sector allocation.

Look for major changes in the portfolio.

Compare the holdings from recent fact sheets to see how much the fund has altered its major stock or sector allocations. This can help you better understand the fund manager's current positioning and approach.

Check Whether the Fund's Current Strategy Matches Its Track Record 

A past performance record is truly useful only if the fund's current strategy and management approach are broadly consistent with it.

Check the Fund Manager's Current Tenure

Check the current fund manager and their tenure in the factsheet. If a significant portion of the fund's strong historical performance occurred under a previous manager, do not blindly compare that performance with the current management's track record.

See major changes in the strategy.

Compare Expense Ratios - But Don't Choose the Cheapest Fund Blindly 

The expense ratio represents the ongoing cost associated with a fund, so it is essential to consider it when comparing two similar funds. However, choosing a fund solely based on the lowest expense ratio is not the right approach.

Compare costs across similar funds.

Always compare funds belonging to the same category and plan type.

In this example, the other factors are roughly the same, so Fund B's lower expense ratio could be an advantage.

Compare Funds Based on Their Investment Style, Not Just Their Category 

Funds within the same category can have different investment styles. Therefore, when selecting a fund, it is important to understand the types of stocks or opportunities the manager prioritizes in the portfolio.

Understand the fund's approach.

Some funds maintain a relatively concentrated portfolio, while others are more diversified. Similarly, some managers may prioritize growth-oriented companies, whereas others focus more on valuation.

Know When a Fund Should Be Removed From Your Shortlist 

It is not necessary to carry every shortlisted fund through to the final selection stage. It is often more practical to eliminate a fund from consideration if certain clear warning signs appear.

Do not ignore consistently poor performance

If a fund has been consistently underperforming its benchmark over a long period without an apparent reason, re-evaluate the justification for keeping it on your shortlist.

The risk exceeds your comfort level

If the fund's downside or volatility is likely to cause you anxiety while invested, it may not be suitable for you, even if it offers good returns.

The fund's current approach has changed

If there has been a significant change in management, investment strategy, or portfolio approach, it is not appropriate to rely solely on past performance to judge the fund in its current state.

Do not be swayed by recent performance alone

If a fund has suddenly started performing exceptionally well over a short period, first determine whether this performance is sustainable or merely the result of a temporary market movement.

Make mutual fund selection easy on Rupeezy.

You don't need to manually check the aforementioned factors across different places. With Rupeezy’s 'Smart Explore' feature, you can view mutual fund categories, fund details, and trending funds all in one place.

Find the Right Category and Funds with Smart Explore

Smart Explore allows you to browse various fund categories, scheme details, and trending funds in a single location, making it much easier to shortlist options.

Conduct a Deep Analysis of Funds in MF Lab

Before selecting a fund, you can view its technical and fundamental analysis in the MF Lab. It simplifies the process of understanding everything from the 'Risk-o-meter' and performance metrics to other key parameters in one place.

Find Funds Based on Your Goals

Whether your goal is to buy a home, purchase a car, or meet another financial target, Rupeezy’s goal-based mutual fund investing feature allows you to explore fund options tailored to that specific objective.

Conclusion

To select the best mutual fund in a particular category, looking solely at returns is not enough. It is essential to consider factors such as the category, consistency, benchmark, risk, portfolio, costs, and investment style. The right fund is one that aligns well with your goals, risk tolerance, and investment horizon.

FAQs

Q1. How do I select the best mutual fund in a particular category?

When selecting a fund in a specific category, compare factors such as performance, benchmark, risk, portfolio, expense ratio, and investment approach.

Q2. Is the mutual fund with the highest return the best?

Not necessarily. High returns can come with higher risk; therefore, it is better to evaluate returns alongside risk and consistency.

Q3. How many mutual funds should I compare?

A practical approach is to shortlist 3–5 good funds within a category and conduct a detailed comparison.

Q4. Should I check the fund's benchmark?

Yes. The benchmark indicates how the fund has performed relative to its relevant market reference.

Q5. Why is the mutual fund portfolio important?

The portfolio reveals where your money is invested across which companies, sectors, or asset classes and shows the fund's actual exposure.