How advisers choose funds for clients

By Ravi Samalad |  28-07-20 | 

With more than 900 open-ended schemes on offer, choosing the right scheme can be a herculean task.

Investors who do not understand the intricacies of various fund style, strategy and risk, seek adviser’s guidance to provide them the right solution to reach their financial goals. Thus, advisers need to select schemes after analysing the pros and cons of each fund category and the schemes.

We asked a few advisers how they go about shortlisting the right funds for their clients. Here’s a look at the most important filters they apply while choosing funds.

Fund house

While outperformance from the benchmark is important, some advisers are also keeping a close eye on the pedigree of the fund house. “I take a top-down approach. To start with, I look at the fund house pedigree. Whether the fund house is acting in investor interest? Is it complying with all regulations? The fund house should avoid launching too many schemes to garner assets. The ownership of the fund house also matters. It should have a stable management. When it comes to choosing funds, I look at the risk-adjusted performance in equity funds. Beta is an important parameter. I look at consistent performers,” says Mumbai-based adviser.

Process matters

For some advisers, the process is more important than having a star fund manager. If a star manager exits, is the fund house capable of managing the funds well? To address this aspect, advisers want to make sure that the fund house has a good team, has a defined fund management process, supported by experienced analysts and senior fund managers.

Risk management

Most fund houses have a dedicated risk management team that operates independently of the fund management team. This team is responsible for putting in place a proper risk management framework and ensure the fund management team operates within these boundaries. Such processes have become extremely important in the light of recent downgrade/credit episodes.

Flight to safety

The credit events in the fixed income space has brought forth the importance of liquidity risk and credit risk in debt funds, which have been pushed as an alternative to fixed deposits.

Many advisers are now trying to rush to most safer categories of funds like liquid, overnight and arbitrage. They are of the view that they might as well take risk with equity funds and use debt funds to protect capital. Dev Ashish, Founder, Stable Investor, looks for debt funds that a predictable style. “Within the shortlist of funds having lower credit risk, my preference is for funds that have a conservative approach towards managing their debt portfolios and have a predictable style and clear thought process. Some other factors are fund size, vintage, concentration risks within funds’ portfolio (to instruments and issuers), expense trends, etc.”


Besides fund performance and processes, many advisers are becoming increasingly conscious of avoiding AMCs that are too focused on increasing their bottom-line at the cost of investors. “I look at how a fund house treats its investors. Is it reducing the total expense ratio (TER) where performance is hard to come by? Some fund houses ask investors to lower their return expectations. But they don’t reduce TER if the performance is slipping. We avoid such AMCs,” says a Delhi-based adviser.

Portfolio positioning  

For Mumbai-based adviser Vinod Jain of Jain Investment, past performance of an equity fund does not matter. Instead, he analyses the current portfolio of funds and the thought process of a fund manager. “Since I have experience in analysing companies and managing our AIF and PMS, I look at the current portfolio of any fund. This gives an idea of how a fund is positioned to benefit in the future. Past performance does not matter to me because it cannot be repeated in the future.”

Fund size matters

While fund managers often say that fund size is not a major determinant of performance, especially when the scheme size becomes large, Vinod begs to differ. “We avoid funds which are too large in size. For instance, in small and mid-cap, we avoid funds with AUM of more than 1,000 crore. In multi-caps, the upper threshold is Rs 2,000 crore and in large caps we avoid schemes having AUM of more than Rs 5,000 crore. We have done an internal study of fund returns over 20 years which shows that smaller sized funds have delivered better than large-sized funds, even where the fund manager is same. We don’t exit funds that go beyond this AUM upper limit; we don’t add more allocation to such funds. Thus, the fund size has to be not too small and too large either.”

Consistent flows matter

It goes without saying that a good fund will attract inflows while a bad fund will see investors exiting. So funds that get consistent inflows indicate that investors have conviction on the fund manager.

“The fund should be getting regular inflows even if the inflows are small. This helps the fund manager look for new opportunities. Funds which are witnessing consistent outflows hamper the performance as the fund manager has to sell stocks to create liquidity,” observes Vinod.

New fund offers are not bad

After SEBI’s recategorization norms, there has been a considerable reduction in new fund launches, especially me-too schemes. But are all new fund launches bad? “We don’t mind recommending NFO if the concept is novel, the portfolio is good and if it comes from a fund house with is known for its performance,” says Vinod.

What to look for in a fund manager?

When Vinod meets a fund manager, he doesn’t ask him about the fund. Instead, he tries to find out about his personality and thought process. According to Vinod, the manager should be dependable even though he may not be the most popular fund manager.

In fixed income, prefer safety over returns

Vinod is a contrarian when it comes to fixed income investing.We exit categories when there is a lot of interest in them and large monies flow into them. The opportunities may diminish once money chases such categories. We usually look for categories which are ignored by most people. For instance, gilt funds was one such category. We have been recommending gilt funds to our clients from the past six to seven years as we anticipated that the economy has a lot of challenges to overcome. This has played out well for us. Now when the performance of gilt funds is in double digits, many investors are rushing to it. When it comes to fixed income, we prefer to take only interest rate risk. Other actively managed debt funds come with three risks – liquidity, credit risk and interest rate risk.”

When the economy is not expected to do well, gilt funds gain as the central bank moves to reduce rates to shore up the economy. Gilt funds do carry interest rate risk. If interest rates fall, gilt funds are hammered. But investors need to have patience for one or two years and not exit in panic. The interest rate cycle is not unidirectional. If interest rates go up, they would come down which will in turn benefit gilt funds. When interest rates go down, equity funds benefit.

Exit strategy

A fund may not live up to its expectations forever. Advisers say that while short term underperformance can be overlooked, consistent underperformance for a sustained period is a clear red flag. If the fund is not doing well, it is advisable to monitor the performance for six months and if doesn’t improve, advisers believe it is best to exit or stop allocating fresh money to such funds.

To sum up, choosing the right fund for your client is an art as much as it is a science. Advisers should focus on both quantitative and qualitative factors while zeroing in on the ideal schemes for clients.

Let us know how you shortlist funds for your clients.

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