Know your fund fact-sheet

Retail investors may not have the wherewithal or time to study and grasp the 40-50-page-long fund offer document / fund information document of a mutual fund. For passive investors the next best alternative is the fund fact-sheet. A fact-sheet is a monthly report prepared and published by a mutual fund for each of its fund offers.

A fact-sheet is a single-page document that explains all pertinent information on the fund and is easily accessible on mutual funds Web sites. Retail investors are advised to read and understand the fact-sheet before making any investment decision. Anyone with a basic knowledge of the securities market can easily understand a facts-sheet. This article dissects the important terms used in such documents.

Assets Under Management

AUM is the market value of assets a mutual fund manages on behalf of its investors. There are funds such as Baroda Pioneer Balance Fund, with an average AUM of Rs 2.6 crore (August 2011), on one side of the spectrum and others such as ICICI Prudential Dynamic Plan, with an average AUM of 3,814.40 core (July 2011), on the other side.

The bigger the fund size, the more the fund can diversify its portfolio. At the same time, large funds may be difficult to manage.

Changes in AUM can be a good indicator of the fund's performance, and can be gleaned by comparing the current month's fact-sheet with previous month's. If the increase in AUM is higher than the NAV returns over the same period, it means that the fund has received inflows, apart from performing well.

Portfolio

Mutual funds are expected to have a diverse portfolio. The portfolio provides information on where funds are invested, what proportion of funds is invested in various sectors and in specific companies. This will help understand the fund's risk profile and strategy.

Portfolio Turnover

Portfolio turnover is the rate of trading activity in a fund's portfolio of investments. It reflects how actively the fund is managed. Portfolio turnover ranges from 0.10 times to three times of the AUM. The more the turnover, the higher a fund's trading costs (brokerage, transaction tax, capital gains tax). Trading costs reduce net asset value (NAV) returns delivered by the fund. High performing funds have an average portfolio turnover of 0.5- to 1.

Expense Ratio

The expense ratio is the proportion of assets used to pay marketing costs, distribution costs and management fees. The expense ratio varies between 1.75 per cent and 2.5 per cent for equity funds and between 1.5 per cent and 2.25 per cent for debt funds. The higher the fund's AUM, the lower the expense ratio. Over a long term of five or more years, a one per cent difference in expense ratio may eat up to 10 per cent of your returns. An important point to be considered here is that expenses are deducted whether a fund delivers good returns or not.

Load

A load is a commission charged at the time of purchase (entry load / front end load) or sale (exit load / back-end load) of mutual fund units. In India, SEBI abolished entry load from August 1, 2009. The majority of Indian mutual funds charge exit loads ranging from 0.05-1 per cent. If investment is held for more than one year many funds exempt exit load.

Return

Returns are reported — compounded and annualised. Generally, returns are reported monthly, half year, last one year, last three years, last five years, and since inception.

If a fund reports 18.6 per cent since inception (1996) it means Rs 100 invested in 1996 is now worth Rs 1197.6. Past performance, though, may or may not be sustained in future.

Standard Deviation

Standard deviation (SD) is a measure of volatility and quantifies the fluctuations of NAV movements. A high SD denotes high risk. Suppose a fund has a SD of 7.9 per cent and returns of 15.6 per cent it means the return may fluctuate between 7.6 per cent and 23.6 per cent. Another fund with 24.10 per cent SD and 15.63 per cent may see its return fluctuate between -8.5 per cent and 39.7 per cent.

Funds with low SD are preferred. Few funds report yearly annualised SD where as others report annualised based on last 36-month data points. Caution, therefore, needs to be exercised while interpreting SDs.

Risk-Free Rate

The risk-free rate represents the interest that an investor would expect from an absolutely risk-free asset. Such a rate is used in risk-adjusted performance measures like Sharpe and Treynor ratios. For calculating Sharpe ratio different mutual funds use different risk free rates.

Sharpe Ratio

Sharpe ratio is one of the most popular risk-adjusted portfolio performance measures. It takes into consideration the return on portfolio, the risk free rate (opportunity cost), and SD. Sharpe ratio is calculated using the formula (Return on Portfolio – Risk Free Rate) /SD. The numerator in the formula denotes the premium that investors gain for taking the risk.

The Sharpe ratio for Axis Equity Fund, for instance was -0.36 as of July, considering a 364-day T-bill as risk-free rate. For the same period, assuming a 91-day T-bill as the risk-free rate would throw a sharpe ratio of -0.48.

In general, the higher the Sharpe ratio the better the fund returns. The point to be noted here is, to calculate Sharpe ratio funds use different time periods. Axis Equity fund use annualised data where as BNP Paribas uses the last three-year data. Hence comparison is nto easy unless one takes similar data points to calculate onself.

Benchmark

Mutual funds use benchmark index to compare the fund performance. Depending on fund portfolio and investment objective, mutual funds choose an appropriate benchmark index. BNP Paribas Equity use S&P CNX Nifty, ICICI Prudential discovery fund use CNX MIDCAP Index, Axis Tax Saver fund use BSE 200, and Franklin India Prima Plus use S&P CNX 500. Benchmark index is also used to calculate the Beta of the fund.

Treynor's Ratio

Treynor's ratio is another popular risk-adjusted performance measure. Treynor's ratio is calculated using the formula: Return on Portfolio – Risk Free Rate / Beta. The calculation and uses are similar to Sharpe ratio except that Treynor ratio uses market risk (beta) where as Sharpe's ratio uses individual portfolio risk (SD).

BETA

Beta measures the co-movement between fund and its benchmark. A beta value of 1 represents that the fund will move in tandem with benchmark index. A beta of less than 1 means fund is less volatile than the benchmark. A beta of greater than 1 indicates that the fund is more volatile than the benchmark. Axis equity fund has beta of 0.89 (July, 2011).

ICICI Prudential Services Industries fund has a beta of 1.07 (Sep, 2011). Higher beta value reduces risk-adjusted returns. For example, if we consider Franklin India Flexi Cap Fund three-year annualised return of 17.2 per cent, risk free rate of 7.9 per cent and beta of 0.86 as of July, the risk adjusted portfolio return (Treynor's ratio) is 10.8 per cent. If we assume beta value as 1.07 then the risk adjusted portfolio return will be 8.70 per cent.

R-Squared

R-Squared represents the fund movements that can be explained by movements in benchmark index. R-Squared value ranges between 0 and 100. A high R-Squared (above 85) indicates the fund's performance patterns are similar to benchmark index.

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