How Do We Choose Equity Mutual Funds? Discover Our Selection Process!

Investing in equity mutual funds can be a lucrative way to grow your wealth, but investors waste too much time in choosing the right funds.

Many DIY investors select funds basis Star Rating or Trailing Returns which have their own drawbacks. Online platforms that give “star ratings” for mutual fund schemes do not make their rating process public, hence making ratings unreliable and non-informative. Also, ranking schemes basis past one year return is short-term thinking and non-consistent.

We have developed selection process to ensure that we shortlist schemes which are consistent and then optimize them for risk, asset allocation and goals. Unlike other online platforms, we want to keep our process transparent for investors to learn and understand our selection process. (Disclaimer: Our process may not be free from errors and personal biases. It is ok, if our process does not feel right to all our readers.)

Our selection process involves several criteria that we use to filter out underperforming and non-consistent schemes. These criteria are designed to identify funds with a strong track record of performance and a “hope” for potential future growth. (Yes HOPE! – we are also relying on past data and future performance may not be same. Please recognize that fund selection is arbitrary beyond a point. You take a chance and hope for the best.)

Anyways more on this in later part of the blog, moving to our selection criteria.

Step 1.) Filtering New Schemes:

We exclude mutual funds that have been in existence for less than 7 years. This criterion helps us focus on funds with a proven track record of performance over a reasonable period. (Around 50% of equity schemes are less than 7 years old & haven’t been through a bear market cycle!!!!!)

Step 2.) Excluding Sectoral/Thematic, FoFs, and Index Funds:

Sectoral/Thematic, Fund of Funds (FoFs), and Index Funds are excluded from our selection process. While these funds may have their merits and can be good tactical bets, our focus is on actively managed diversified equity funds that have the potential to generate alpha in every market phase not just during a period when theme/sector is playing out. Also, catching a theme and exiting it at right time is difficult. We prefer to not spend time on choosing which theme/sector will play out next.

Step 3.) Industry and Category Benchmarking:

We benchmark funds against industry and category averages to ensure they are outperforming their peers and benchmark. This helps us identify funds that have consistently delivered above-average return and are top quartile schemes in their respective categories.

Step 4.) Consistency in Rolling Returns:

We evaluate the consistency of a fund's performance by analyzing its rolling returns over multiple time periods. We analyze past 20 years of data to shortlist schemes that exhibit consistent performance. We prefer schemes which have outperformed their benchmark at least 50% of the time. (“only 50% of the times” because expecting more is bit of high ask. Active schemes may not outperform at all times.)

Step 5.) Quantitative Analysis:

We analyze various ratios, including Beta, Standard Deviation, Sharpe, Sortino, and Alpha, to assess a fund's performance and risk profile. These ratios help us make informed decisions about the fund. However, do not read into ratios too much.

That’s it. We are done. (It requires much more time then you think it does for above filtering process)

By following only these 5 steps, we filter out 98.5% of equity schemes. Our process is designed to shortlist funds with the highest potential for delivering returns while managing risk effectively.

While we take pride in our meticulous approach to selecting equity mutual funds, it is important to remember that selecting the right equity mutual fund scheme is not possible! No, we are not saying investors should abandon mutual fund selection but without sound review strategy, the selection process is of little use (unless you get lucky!). More on reviewing mutual funds in next blog.

Even after filtering 98% of schemes, we are left with almost 30 schemes. Scheme selection would still require user discretion, random selection, coin flipping or our favourite – Akkad bakkad bambe bo.