Mutual Funds have an investment objective and are managed by professional fund managers. They are accountable for the fund’s optimal performance in achieving the investment objective. Furthermore, the performance is influenced by many other factors. Know the different factors that affect the returns of mutual funds
6 Factors That Affect The Returns Of Mutual Funds
Following are the factors that affect the returns of mutual funds:
Performance Of Underlying Securities
Mutual fund schemes have a predetermined asset allocation strategy and investment objective. Based on the strategy and objective, the fund manager invests the money received by the fund in various assets. For instance, a fund indicates that it will invest around 80% of its assets on equities and equity-related products. And the remaining funds i.e., 20% across debt and money market securities. Thus, it is necessary to maintain this ratio while investing.
Since the fund invests in a particular type of asset, its performance is heavily dependent on that of the underlying securities. This implies that the fund’s performance may vary according to the underlying securities. For example, if the stocks held in the portfolio lose value, the fund’s NAV is expected to fall, and vice versa.
Well, fund managers strategically diversify their investments across several industries and market capitalizations depending on their understanding of the economy. This allows them to mitigate the impact of any underlying security’s poor performance. Therefore, the performance of the mutual fund will be highly dependent on the performance of the underlying securities.
Fund Manager and His Team of Experts
Fund managers oversee the majority of mutual fund investments. It is safe to conclude that managers are crucial to the success or failure of an investment. Fund managers’ decisions and strategies will significantly impact a fund’s success.
They must regularly analyze and evaluate their portfolio and make any required modifications. They receive real-time updates on market performance, examine investment objectives, assess risks, ensure regulatory compliance, and safeguard client assets. They take advantage of market possibilities and invest in schemes at the optimal moment and method.
Thus it is essential to evaluate the strategies and expertise of the fund manager of the fund you have chosen to invest in.
Size of the Fund/ Asset Under Management (AUM)
The total value of the investments in a mutual fund is referred to as Assets Under Management (AUM). AUM is a useful indicator for determining a fund’s performance and popularity.
The size of a fund’s total assets or assets under management has a significant effect on determining its performance. A popular fund with high inflows can boost the fund’s performance, but as the size of the fund grows, the fund management must become more responsible and precise with their decisions. Additionally, at a certain size, the fund becomes difficult to manage. A poorly managed huge fund is likely to perform poorly.
The size of the fund cannot be so great that the portfolio becomes unmanageable, and asset management firms must ensure this.
It is essential to keep a healthy AUM. It should be neither too little nor too huge. This is because the fund’s size directly influences its performance and ability to generate returns. Alternatively, if a fund is too tiny, managers will not have the leverage to diversify its holdings.
The total expense ratio refers to the fund house’s fees or costs imposed on investors. It includes commission, brokerage fees, and operations costs. These fees contribute to the operation of a mutual fund scheme. The expense ratio plays a critical part in determining an investor’s returns. Higher expense ratios will result in lower profits, whereas lower expense ratios will boost a mutual fund’s return potential. Therefore, investors must carefully review the scheme-related documentation before investing and look at the expense ratio keenly.
A mutual fund pools the funds from various investors who share the same investment objective and risk tolerance level and then invests the funds in various financial securities. If a large number of investors show interest and invest in the same mutual fund, the fund managers will have a substantial quantity of capital to allocate among various securities in order to generate significant returns. They can diversify their portfolio by investing in numerous industries and geographies. Therefore, positive cash flows will improve the performance of any fund.
Suppose, if the fund begins to underperform, many investors may withdraw their money. Thus, leading the fund manager to liquidate assets in order to meet all the redemption requests. This abrupt and immediate cash redemption from the fund may significantly alter the returns. Thus impacting the mutual fund’s performance due to a lack of resources for portfolio diversification.
Investors must monitor new economic and emerging trends in any industry. Economic changes in any industry may affect a fund’s performance positively or negatively. Changes in government policies pertaining to a sector will impact the stock prices of companies in that area. This will also impact the Net Asset Value (NAV) of a mutual fund whose fund corpus is invested in these stocks.
For instance, if the manufacturing sector witnesses some favourable policy changes, there will be a positive impact on stock belonging to the sector. Thus, units of mutual funds investing in these equities will generate positive returns.
Similarly, during the COVID-19 pandemic, the stock prices of numerous pharmaceutical and drug businesses increased exponentially. Therefore, the value of mutual funds investing in stocks of such companies has witnessed significant growth.