How do I choose Mutual Funds

One thing that bugs most people while investing in Mutual Funds
is selecting the right one. And most agents doesnt guide you as
they push mutual funds which offer them higher commision. If one
tries herself, she will be overwhelmed by data. So, I thought let me
share my way of doing it.
Personally, I do invest in direct equity as well as mutual funds. In
equity, I invest in only companies with sound business model while
in mutual funds I like to look at the their historical performance.
WTF? You must be thinking that dont they say past return is not
an indicator of future performance but it provides very good
indicators about the future.

Example
I will use an example of myself to and zero down on best mutual
funds.
To make high returns
Can take losses in short-term
Only credible mutual fund schemes

Initial Assumptions
There are 20K+ mutual fund schemes. They are broadly three
types
1. Open: You invest and redeem anytime
2. Closed: You invest only during the start and redeem when it's
tenure ends
3. Interval: You can invest or redeem only some pre-defined
dates
I will only talk about open mutual funds as they provides
maximum value to a retail investor.
Mutual Funds Schemes Left: ~5k
Next major classification is on frequency of dividend.
1. Growth: No dividend is paid
2. Dividend: Dividend is paid for
Daily/Weekly/Monthly/Quarterly/Annually

For our analysis, I am considering only growth option as it makes

returns calculation easier.
Mutual Funds Left: 900
We reduced our universe from 20k to 800 but still we need to
reach to top few.

Mutual Fund Selection:

First thing you need to classify the data into three parts. This help
to make sense of the data is better manner.
Filters: Category, Sub-Category, AMC, AUM, Age
Sorts: Returns, Risk
Review: Portfolio, Exit Load, Min Investment

Filters
Filters are basically are eliminating criterias.
1. Category of Mutual Funds:
1. Equity: invest in equity they are risky but provide high
returns
2. Debt: invest in bonds (give interest) issued by
government, banks and corporates. They are safe but
provide low returns
3. Hybrid: invest in both equity and bonds they have
moderate risk and provide moderate returns
4. Others: invest in gold, real-estate, commodities, etc.
They are also of moderate risk and provide moderate
returns
I am fine with high risk but want high returns so I would select
Equity.
Mutual Funds Schemes Left: 400
2. Sub- Category of Equity Mutual Funds:

a. LargeCap: invest in stocks of large company with

market cap more than $5B. They are relatively less
risky
b. MidCap/ SmallCap:
invest in stocks of medium/
small companies with market cap less than $5B. They
are relatively more risky.
c. MultiCap: invests in both large, medium and small
companies. They are relatively more risky.
d. Sector Funds: invest in specific sector like IT, Pharma,
Banking. They are considered risky as they have sector
specific risk but some sectors like pharma, IT are
inherently less risky.
e. Others: invest in themes, etc. They are also high risk.
I can take risk and I dont believe in a sector that will do better
than others. So I choose MidCap/ SmallCap.
Mutual Funds Schemes Left: 40

3. AMC, AUM and Age

f. AMC: Mutual fund companies. I feel companies, which
are old but still have decent traction is kind of red flag.
Negative list of AMCs: Escorts, Sahara, Shriram and
Quantum
g. AUM: for Small/Midcap <5,000 Cr and >100 Cr
h. Age: Atleast 5 years
Mutual Funds Schemes Left: 32

Sorts
Sorts can be used to select the best funds.
Two things that are important to select the best funds are high
returns and consistency of the returns. To do that, follow the steps
below:
1. Sort the funds by 1 year returns and highlight top 10

2. Sort the funds by 3 year returns and from top 10 change

highlight of common funds
3. Sort the funds by 3 year returns and from top 10 change
highlight of common funds across all three.
Mutual Funds left: 4

Review
Review is to do a deeper analysis of each of these funds from any
constrains or risk perspective.

1. Minimum Investment Amount: See if falls into your

affordable range
2. Expense Ratio: Lesser the better. Returns are uncertain
whereas expenses are fixed
3. Exit Load: Generally its 1% within 1 year for equity and Nil
for debt. If its higher be sure that you wouldnt withdraw
before exit load
4. Portfolio: Look for any red flags like very few stocks (less
than 20), too many stocks (more than 50), Sector
Concentration, High valuation (P/E or P/B), etc
5. Advanced Measure: Sharpe Ratio should be above 1, Std Dev
to be on lower side
Some mutual funds are not accepting new investment. So need to
reject them as well.
So finally for me following Small/Midcap funds are
1) DSP BlackRock Micro Cap Fund
2) Franklin India Smaller Companies Fund
Thats it. Now you can invest 50% into each of them.
Hope this helps. I would write a separate blog to talk about criteria
for other categories.