Should you Ignore Past Returns while Investing in Mutual Fund?

Most of us consider past returns as a benchmark for future performance of any mutual fund, but with the change in the rules made by SEBI, this parameter has become an inappropriate tool.

Re-Categorization of the companies

Previously, there was no parameter to classify companies as large, mid-size and small caps. Each fund house would have a separate criterion for the same. This would lead to the difference while comparing two funds.  For example, UTI Mid Cap Fund would invest at least 65% of the assets in equity and equity related mid cap funds, which were part of CNX Mid Cap Index or S&P CNX 500 but was not a part of BSE Sensex 30 or Nifty 50, while SBI Mid Cap Fund categorize mid cap as the stocks that fall under the category of 101 and 400 stocks, when ranked in terms of market capitalization.

As per the new rules laid down by SEBI, top 100 companies will come under the head of large cap, 101 to 250th companies will fall under the category of mid- caps and above 251 will fall under the ambit of small cap. Coupled with that, SEBI has maintained the minimum investment criteria for large, mid cap and small cap. The mid cap fund, is now required to maintain at 65% of the investments in the midcap stocks. This, in turn, would not lead to apple to oranges comparison.

Changes in FPI

SEBI has recently constituted a committee and has proposed wide reforms to the foreign portfolio investment that is aimed at improving foreign capital inflows. SEBI has introduced liberalized investment caps, easy-on boarding and other reforms. So, the foreign investors need to go through the past returns before investment.

Price to Total Return Index

Earlier the performance of equity mutual fund schemes was benchmarked to price return variant and the fund managers totally ignored income generated by the assets in form of dividends, but now SEBI has asked the fund houses to benchmark the performance to Total Return Index. The TRI will take into account the dividend received by the stock too, which will help in a fair comparison.

One scheme per category

SEBI has introduced a new rule that suggests that the fund houses can launch only one scheme per category. The overall impact is, the fund houses have now merged the existing schemes and has brought forward a single scheme.

For instance, HDFC Mutual Fund has two balanced funds HDFC Prudence and HDFC Balanced Fund. Both the funds have emerged and has created a new fund named as HDFC Hybrid Equity Fund. The fund now belongs to balance category.

This means, now the investor should consider not only the past returns for selecting the mutual funds, but host of other factors to make a sound financial decision.