Here is a complete-detailed list of the Factors affecting Mutual Fund Performance, either minor or majorly.
Investing in mutual funds is a huge financial decision for several individuals. It might seem even a little complex at first.
If you can manage to stay invested for the long term, you can yield higher returns and greater benefits.
One can choose from various kinds of mutual funds available in the market depending on his/her preferences and risk tolerance.
About Mutual Funds
All investors are free to choose from two different kinds of mutual fund schemes- Direct and Regular mutual funds.
In a direct mutual fund, there will be no provision of a financial intermediary. You cannot find anyone like an advisor, a broker, or a salesperson.
In a regular one, such intermediaries are present, who take their part of the commission from your profits. Hence, in a way, they deplete the performance of your mutual funds.
Once you have decided which method of investment to choose, you can now consider whether to select a one-time investment plan or a Systematic Investment Plan (SIP).
Generally, people associate a one-time investment with the riskier ones. It is because of its ability to either fall or rise completely in a fluctuating market.
Of course, SIP is a safer bet, but the amount of returns gained from any investment plan depends on your skills as an experienced investor and your ability to handle this risky business.
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Factors Affecting Mutual Fund Performance
These are the basic factors that might affect the performance of your mutual fund.
- Changes in the Markets/Sectors/Industries
- Underlying Securities
- Total Expense Ratio (TER)
- Fund Size
- Flow of Cash
Lets have a detailed discussion on these Top 5 Factors that affects Mutual Funds Performance & How you can identify these factors and mitigate losses or increase profits.
Changes in Markets/Sectors/Industries – Top Factor Affecting Mutual Fund Performance
Fluctuations in markets and economic sectors are one of the most important factors. It determines the performance of a mutual fund scheme.
A few policy changes made by the concerned government can also highly impact the performance of a mutual fund scheme.
These unanticipated changes can lead to an increase in the number of construction projects. As a result, the demand for materials like steel, concrete, cement, etc., will also increase.
Hence, the stock prices of the companies manufacturing these materials will see growth. If a mutual fund has invested in these markets or sectors, it will experience a significant boost in its performance.
On the other hand, if government-made policy changes negatively, it impacts a specific sector or industry, and the value of stock prices will drop.
This will further cause a negative ripple effect on the value of mutual schemes that have invested in those markets.
Underlying Securities – Major Factor that Impacts Mutual Funds Performance
Based on calculated risks and asset allocation, a mutual fund invests in an extensive range of securities.
For example, an investor can invest 80% of his/her investible corpus in instruments related to equities. The remaining 20% gets invested in debt and money market instruments.
Here, the fund has invested in different securities. The performance of the mutual fund will depend on how these securities perform.
If the equity market crashes, then only 80% of the investment portfolio will get impacted. Normally, the volatility of equity markets governs the performance of equity mutual funds.
In the case of debt funds, an investor has to look at the interest rates. He should also check credit risks related to the assets.
Based on a good understanding of the economic sector, you can work on this. This kind of diversified investment portfolio can help to mute the negative impact of a market change.
Hence, the overall performance of a mutual fund remains neutral. Fund managers can diversify investments across sectors, market capitalizations, geographies, etc.
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Total Expense Ratio (TER) – Factors that Affects Mutual Funds Performance
It is the management fees charged by an Asset Management Company (AMC). The expense ratio of your fund also impacts your mutual fund’s performance.
Every fund house charges a minimal fee for management, marketing, office, and clerical work. Additionally, you need to pay for operational expenses like trading fees, legal fees, and auditor fees.
So, your net profit earned will be the total gains from the investment minus expense ratio and management charges.
Many investors consider that the difference in the returns of direct and regular mutual funds is quite marginal.
But if one sees it in terms of a long-term investment, the expense ratio of direct mutual funds is less. It would prove to be much lesser as compared to the regular ones.
The Total Expense Ratio of a mutual fund can range from 0.5 to 3%, depending on numerous factors. Generally, positive scale economies arise from the capabilities of larger management firms.
As a result, this can have a positive impact on your overall mutual fund performance. But if the size or quality of your fund house is not up to the mark, it will minimize the number of your returns.
Fund Size – Top Factors Affecting Mutual Funds Performance
The size of the fund is another essential factor that plays an important role. It disturbs the performance of an investor’s mutual fund.
The larger a mutual fund grows in size, the responsibility of the concerned fund managers also increases. Hence, the skills required to manage the assets of the fund also increases.
However, there is a limit to which the size of a fund can increase. If a fund grows beyond a certain size, it can become difficult for the fund managers to handle it.
Increasing the fund size also increases the likelihood of liquidity constraints. Besides, it may hamper the decision-making process of a mutual fund investment.
The decisions will get made multilaterally by the whole team instead of an individual manager.
The asset base of a fund becomes too large to effectively invest it. The fund has reached its saturation points, the managers can call for a Soft Close.
This means that the existing shareholders can buy shares of the fund. No more investments will happen in that particular fund. Eventually, it becomes the responsibility of an investor.
He should go through all the details very carefully while investing in their preferred mutual funds. Poor management of a large fund will certainly lower the performance of your mutual funds.
Flow of Cash – Well-known Factor that Impacts Mutual Funds Performance
Since a mutual fund works on the principle of collecting money from investors, more number of investors implies more chance for a fund manager to further diversify investment portfolios.
This enables the manager to invest in larger quantities of mutual funds that would reap higher returns.
Therefore, a large number of investors can increase the chances of yielding better returns for the mutual fund, enhancing its overall performance.
One can say that the cash flows from a pool of investors can determine the performance of both the fund and the fund manager.
On the other hand, if the fund is underperforming consistently, it would cause some of the investors to pull off their investments.
Consequently, the fund manager would have to sell a part of the holdings to handle the redemption requests of investors. This would impact the performance of a fund negatively.
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Factors Affecting Mutual Fund Performance – Conclusion
Numerous external factors can affect the performance of a mutual fund in the market area.
While it is essential to keep all the above points in mind, an investor must also be aware of his/her financial goals, the sum of money he/she can invest, and the number of risks they are ready to take.
Since the performance of a mutual fund highly depends on the decisions taken by the fund managers, they have to make the best of their efforts to decide on these investments.
These decisions can be on the basis of the current prices, quality, risk tolerance, news flow, and economic developments in the country.
A good fund management team will comprise of managers who have sound skills, relevant experience, and an ability to take calculated risks according to the changing markets.
You can enhance the performance of your mutual fund scheme by avoiding large funds. But, if you are targeting international markets, medium to large funds can be highly efficient.
You can also measure the performance of your fund using realistic time zones. In the end, it is your responsibility to choose wisely and logically.
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