Should you evaluate a fund manager's performance before selecting a mutual fund?

Investors look at past returns, expense ratio, etc when they evaluate a mutual fund for investment. One of the parameters most investors don't consider is the fund manager's performance. 

When the market's overall condition is good, mutual funds perform well. When the market goes through a tough time, a fund manager's skill and talent make a difference. In both scenarios, having a talented fund manager can do wonders for your mutual fund portfolio. 

In a positive market, a good fund manager can generate alpha for you. While in challenging situations, they can protect the downside of your portfolio. Therefore, before you pick a mutual fund for investment, you must evaluate a fund manager's performance. An important question is how a novice investor can do it. Let us look at the parameters for evaluating a fund manager.

Parameters to evaluate a fund manager

You may have shortlisted the funds for investment but are unable to finalize one (or more) of the funds for investment due to a small difference. In such situations, you can evaluate the fund manager on the below parameters to pick the final funds:

Fund manager's investment style:

You must try and figure out how the manager handles the portfolio - does he keep cash reserves or is fully invested? Also, look at his picks (stocks in the portfolio) - does he pick traditional stocks or make some unusual picks? Whatever the case, he should have a clear strategy. It will help you determine whether his strategy is consistent with your investment goals. Below are a few different parameters to evaluate the investment style of a fund manager:

• Aggressive or conservative style: The aggressive style of a fund manager may suit investors with short investment horizons as they can generate alpha with aggressive buying.
• Value or Growth style: Look at the stocks the fund manager picks - quality stocks that are available below their intrinsic value, or they invest in growth stocks that can generate higher returns for you.
• Credit risk style: Investors looking for debt funds must evaluate the investment style based on the credit risk style. You must see if the fund manager invests in AAA-rated bonds or if they have lower-rated bonds in the fund.

Invest as per the mandate:

Every mutual fund scheme falls under a specific category. For example, a large-cap mutual fund must have a minimum of 65% of its assets allocated to large-cap stocks. An important thing to note is whether the mutual fund manager abides by the mandate. A rare miss is fine, but if the manager has a habit of missing the mandate, you must have second thoughts about the fund.

Investment time horizon:

There are two types of fund managers - one who churns the portfolio frequently, while the other picks a stock and holds it for a long time. Investors may look to go with managers who come under the latter category - holding a stock for a long time shows conviction in decision-making. Also, you must note that frequent buying and selling of stocks increases the costs for the fund and eventually lowers your profits (or gains).

History of managing funds:

If possible, look at the previous funds of the fund managers and see how they have performed under their tenure. If they have recently taken over the fund that you plan to invest in, you can evaluate their past funds to learn more about them and their investment style.

Number of schemes the manager handles:

You must also check the scheme count under a fund manager. If there are too many schemes the fund manager manages, you must try to find the team size. If the manager has a team of analysts, handling many schemes should not bother you. If not, you may reconsider investing in such a scheme.

Should you sell a mutual fund when the fund manager leaves?

If a fund manager's role is crucial, should an investor exit a mutual fund when a manager exits? Ideally, you should not be doing it. As per experts, the easiest thing would be to wait for three to four quarters and monitor the fund closely. While comparing, make sure you don't compare the fund's performance in two market cycles. If you see the fund's performance down compared to peers and category benchmarks quarter on quarter, it is a red flag, and you must dig deeper to look for reasons. We discussed investing styles above, so check if the new manager has switched to a different style. 

Please note that if you exit a fund only because a fund manager exited, you will have to incur short-term (or long-term) capital gains taxes. Evaluate your investments and evaluate from every angle before you decide to exit from the fund.

Conclusion

A fund manager has the potential to turn mutual fund returns in favor of investors, and hence investors must evaluate a fund manager's performance. You may not evaluate a fund manager on all the above parameters, but knowing them better on a few parameters will surely help you pick the right mutual fund.

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