Understand the jargon of a Mutual Fund
If you’re someone who has tried to analyze a Mutual Fund, but is confused about the different terminologies used on various websites like Moneycontrol, ValueResearchOnline and the others, then this article is for you. I’ll try and make sure that after the next 7 minutes, you’ll be able to understand all the complex financial terms used in Mutual Fund analysis.
Please note, however, that this is the first article in the series of 4 articles that I’m going to write about Mutual Fund analysis and the jargon involved. So if you want to become a pro at this, make sure you follow all 4 articles by subscribing to this newsletter in case you still haven’t done so. 28 minutes to become proficient at Mutual Fund analysis doesn’t sound like a bad deal at all ;-)
Anyway, coming back. If you open any website such as MoneyControl, ValueResearchOnline or even the newer Wealth platforms like Groww, INDMoney etc to check out a Mutual Fund, you’ll see a lot of complex financial terminologies while analyzing a Mutual Fund. Don’t worry, I’ll simplify that for you. Let’s pick up the Money Control website and begin.
[First, if you’re not aware of the basics of how a Mutual Fund works, please read a quick brief here and then come back to this article]
Coming back, I’ve taken Axis Long Term Equity Fund as an example. Please note that this is not a recommendation. Let’s start with the first few things that you see on Money Control (In this article I’ll only explain the jargon; like I said, we’ll delve deeper into the analysis bit in the next few articles). It would help if you open the Money Control website in parallel and play around.
Some of the terms that you see are:
Fund House (on the extreme right of the image)- this is the name of the company that is selling this Mutual Fund Scheme. It’s called as the AMC (Asset Management Company - remember this abbreviation, we’ll be using it a lot). Axis Mutual Fund is therefore the AMC, which has multiple “Mutual Fund schemes” that they offer. One of those schemes is Axis Long Term Equity Fund.
Next, you see a term called “Fund Size”. This basically means - the total value of the money invested in this Mutual Fund as of today. You are one investor; similar to you, there are thousands of investors (both - individuals and companies) who invest in that Mutual Fund. This cumulative sum invested by all of you is known as the Fund Size or AUM (Asset Under Management - remember this too - we’ll use it time and again).
An important term that you see here is the Expense Ratio. Now, obviously, for managing your money, there is a cost that the AMC will incur - there is a fund manager who needs to be paid a salary, there is a cost for running the office, a research team to do research, and other things. That cost forms a part of the expense ratio of the Mutual Fund. To simplify it, if the AUM of the fund is Rs. 1,000 crores and the cost of running the Mutual Fund scheme is Rs. 10 crore, then the expense ratio of the Mutual Fund Scheme will be 1%. Think of it this way - for every 1,000 bucks you invest in a Mutual Fund, 10 bucks go to the AMC for managing the fund, and the remaining money is invested. In reality though, the calculation may not be that simple. But you get the point :)
Now, it goes without saying that the Expense Ratio of the fund should be as low as possible, because a higher Expense Ratio means more cost of managing the fund and therefore lesser returns to you. But we’ll cover this in detail in upcoming articles.
There’s a term called the NAV, which stands for Net Asset Value. It is nothing but the price of one unit of the Mutual Fund. Basically, somewhat similar to company shares, Mutual Funds are also issued in units. So if the AUM of the fund is Rs. 1,000 crore, its expense ratio is 1%, and there are 1 crore units of the Fund which are issued, the NAV (or price) for each unit is
[(AUM - Expenses)/Units]
= [(1,000 crore- 10 crore)/1 crore] = Rs. 990
This above AUM-Expense Ratio-NAV calculation is extremely simplified. I’ve written about it in detail here. You can have a look at it if you want to delve deeper, and then come back to this post:)
Growth: This denotes the type of plan. There are 3 kinds of Mutual Fund plans typically:
Growth: Here, the money that your fund is making, is not paid out to you frequently, but again invested in the same Mutual Fund, thereby increasing the NAV of your fund, and thereby giving you much better returns. This should be the preferred option if you don’t need periodic payments from your Mutual Fund - it compounds your wealth because your returns are invested again, which then earn more returns
Dividend: If you’re someone who wants regular income or payout, you can go for this plan. Here, periodic payouts out of the profits are done by the Mutual Fund company to you and therefore the NAV doesn’t appreciate as much as it does in the Growth plan - but you do get a regular income stream
Dividend Reinvestment: This is similar to the Growth option. Here the dividend being paid out by the Mutual Fund is reinvested in the portfolio. However, the taxation here is different. Let’s not get into the taxation piece here. We’ll keep it simple and say that the Growth option is the best option for a young investor/someone who doesn’t need frequent payouts
Now, you can also see a term called “ELSS” under “Category”. ELSS means it is an “Equity Linked Savings Scheme”, which means investing in it enables you to claim a tax deduction of the amount invested. I’ll write the details about it in another post. Essentially, the “Category” of a Mutual Fund shows what type of products this Mutual Fund is investing is. For example, a Large Cap Equity fund invests in stable, large company stocks, like HDFC Bank, TCS etc. which are big companies and therefore, relatively safer. A Small Cap fund on the other hand invests in smaller company stocks, which carry a higher risk but also have the probability to give higher returns.
I’ll do another post on the different categories of Mutual Funds later. Let’s not lose focus :D
Some other categories of an Equity Fund are as below:
Then, we can see two radio buttons with REGULAR and DIRECT written. Essentially, there are two types of plans that you can opt for - one is a Regular plan, where you go through an intermediary “Mutual Fund Distributor” who is an individual or company that will help you make the investments. The second is a Direct plan, where you will invest directly on the AMC website (or a platform that gives you direct plan investing options) without going through a distributor. Now, obviously if there is a distributor, he/she will earn some commission from the AMC. Since it is a cost for the AMC, it forms a part of the Expense Ratio (I hope you remember, it was not too long ago :p). Therefore, a Regular plan will have a higher Expense Ratio compared to a Direct plan.
So when would anyone opt for a Regular plan if it has a higher expense? They’ll do it when they’re not subscribed to this newsletter and are not aware of how Mutual Funds work and how to analyze them :p
Okay, jokes apart, people generally go through a distributor and take regular plans if they need guidance on choosing the best plan for themselves. Since distributors are qualified to give the right advice, a good distributor makes sure their clients don’t end up choosing the wrong Mutual Fund scheme. And for the investor, choosing a plan with a slightly higher expense ratio is better than choosing a wrong plan and ending up in losses. The returns more than cover up for the higher expense ratio.
Then you see a CRISIL Rank. This is typically a rank/rating given by the credit rating agency CRISIL to the Mutual Fund, based on various parameters. The rank can be an indicator of how good or bad the Mutual Fund is. However, this rank keeps changing, so a #1 fund today may not be a #1 fund after a year or 5 years. So make sure that the rank is not the only indicator of a Mutual Fund performance for you
And the last thing you see here is the Risk-o-meter. This bit is self-explanatory. It shows how risky the fund is. For example, a Mutual Fund scheme that invests in smaller companies in the stock market may be more risky than a Mutual Fund scheme that invests in bigger, stable companies like HDFC Bank or Infosys. This parameter indicates how risky the Mutual Fund scheme is
Okay I wanted to do 10 points in this article and get a rounded off number, but there’s only 9 items here, so I couldn’t do more :p
Anyway, this is part 1 of the series where you can understand the jargon in a Mutual Fund. Hope it helped!
Over the next 3 weeks, I’ll send out some more newsletters that’ll explain different aspects of a Mutual Fund. In a month from today, you should be able to understand and analyze a Mutual Fund yourself. However, if you want some advice on this, you can feel free to reach out to me on ankurAjhaveri@gmail.com
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