The world over there is a perceptible shift in funds from ‘managed’ funds to ‘index’ funds. I do not want to get into whether index funds are passive funds – that is a different topic!

So just when you thought people had decided that fund picking does not work, you see them making a mess in choosing a debt fund – this too is a different post.

I wanted to instead talk about how do people pick a fund scheme in which to invest. They think they are very smart and they tell me that they pick only the top funds from a rating website AND THEN STILL do research. In my view that itself is wrong. Picking a top rated fund from a website is perhaps a wrong first step! When you look at Prashant Jain’s 25 year track record, you realize that you are plain lucky if you were an investor. What did I know about Hdfc or Franklin Templeton in 2000-2002 when I invested in them? Not much if you ask. Literally nothing, actually.

In case of Hdfc it was more the amazing stock picking skill of the Hdfc group – even now the Hdfc Ltd balance sheet has some good shares, the power of the brand, and the sheer fact that I did tons of training for them. Sounds stupid, does it not? I only knew Milind Barve at that time – and precious little about the process (I assumed it had a process). I didn’t know much else.

In FT I knew Suraj Kaeley who was (is?) the only sales guy who would talk about the investing process. Hello, I am talking of 1999 – not 2019! I remember asking him who will invest in this “Temple”….but I did.

Now I would say don’t look at ranking at all. Just do not. Ask your fund about the fund philosophy, processes, and then see how they have implemented it over the past few years. Sometimes when a fund house achieves results by breaking its own philosophy you keep wondering whether to mourn or celebrate. However, the SEBI norms are now useful that you will not find a midcap fund stuck with large cap stocks or vice-versa. However the ‘value’ and ‘growth’ etc. – you need to leave it to chance.

One another parameter that you can look at is the cost. The lower the cost, the better it is for you. However, remember that expensive fund managers don’t come free. Warren Buffett is of course an exception, but then WB should be compared to Mukesh Ambani, not to Prashant Jain – he is only a manager.

You can size up a manager’s analytical process by seeing how the portfolio differs from the average portfolio in that category. If the names and size of the top holdings are essentially indistinguishable from those of an index fund in the same market, you are looking at a closet indexer. Surely you aren’t looking at a future superstar.

A manager with a good behavioral process makes decisions based on policies and procedures, —and doesn’t credit good returns to his own brilliance while blaming bad results on irrational markets, financial crises or bad weather. The manager’s monthly letter should give you a feel of what he thinks – but remember these days the person drafting the monthly letter could be trained in communication and be different from the fund manager.

Finally, is the firm owned by a big giant that cares only about maximizing its own profits? Did the fund launch when its investments were so popular they were overpriced? Has the manager closed funds to new investors when too much money came in to manage prudently? Ha does that ever happen?

Only after a fund or other investment strategy passes these tests should you even bother to look at its performance. That is at least as true for bond funds as for stock funds. So can you find out about the culture of the fund house? Do they tell you enough about their processes, their mistakes, and their corrective action? Do they tell you that a “watch dog committee” compares the philosophy and what is really being done (ha, the auditor in me is still alive)…or is it luck.

And if you aren’t willing to spend the time ruling out luck as an explanation for performance, exercise a simple skill of your own: Buy an index fund instead – or an ETF.

Ask fund houses to put out their investment philosophy statement. Believe me that is more difficult than being lucky.

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  1. If indian mutual funds are put thru the wringer and expect them to pass the above tests then no funds will pass muster. As Malkiel said just throw the darts randomly and pick the funds and hold it for long. It should give decent returns. No AMC publishes the process, their philosophy, and the mistakes they made. Whatever is published are just politically correct statements and sales pitches which we all want to hear.

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