A Few Terms You Should Know and What They Mean for You
Assets Under Management (AUM)
Assets under management are the overall market value of assets/ capital that a mutual fund holds. AUM is important because as per SEBI mandates, mutual fund companies are allowed to charge expense ratios based on the AUM slabs of the scheme. We will of course spend some time understanding expense ratios as well.
Net Asset Value (NAV)
NAV is calculated by dividing the total net assets of a portfolio (assets minus liabilities) by the number of units outstanding. This is the price at which investors buy units from a fund house or sell them back to the fund house.
The NAV of a fund is calculated at the end of every trading day, after taking into account the closing market prices of the securities that the fund or scheme holds and hence solely depends on the underlying securities.
You should also know that there is a cut off time applicable to NAVs. For Equity schemes the cut off time both in case of purchase and sale of units is 3:00 pm. Simply put if Mr. A invests ₹10,000 on Thursday before 3:00 pm, he will get Thursday’s NAV. If he places the order post 3:00 pm he will get Friday’s NAV. The same concept applies to sale of units.
Total Expense Ratio (TER)
The total expense ratio (TER) is a measure of the total costs associated with managing and operating a mutual fund. These costs typically include Management Fees, Administrative Fees and Distribution Fees.
Expense ratios indicate how much the fund charges in percentage terms annually to manage your investment. If you invest Rs. 10,000 in a fund which has an expense ratio of 1.5%, it means you need to pay 150 Rs. to the fund house to manage your money. So, it can be said that if a fund earns 10% and has a 2% TER, then it means an 8% return for an investor. TERs for equity schemes range between a maximum of 2.25% and 1.05% (can be lower). The TER slab depends on the Scheme’s assets under management.
Naturally, all else being equal a fund with a lower TER is preferable when compared to a fund with a same investment style and comparable returns but having a high TER.
Standard Deviation
Standard deviation is a statistical tool that measures the deviation or dispersion of the data from the mean or average. When seen in mutual funds, it tells you how much the return from your mutual fund portfolio is straying from the average return, based on the fund’s historical performance. For e.g. if the portfolio XYZ has a standard deviation of 7% and average return of 15%, it means that it has a tendency of deviating by 7% from its expected average return and may give returns between 8% to 22%. Standard deviation is directly proportional to the volatility of the portfolio.
Needless to say, when investing in a fund with greater standard deviation, expect greater volatility. However, the volatility or risk is not just limited to the downside, but rather a deviation from average both on the upside as well as downside. Thus, it is important to construct a portfolio that is suitable to your goals and desire to bear volatility.
Alpha
An alpha will give you an idea of excess returns that your invested fund may generate compared to its own benchmark. For e.g. If a mutual fund scheme has an alpha of 3 it means it has outperformed its benchmark by 3%. So if its benchmark gave a return of 10% in a specific year, the scheme gave a return of 13% for that same period. Alpha can also be negative if the scheme underperforms.
When evaluating a scheme, it is important not just to focus on the most recent period returns or alpha, as these should never be looked at in isolation. While past performance is no guarantee of future returns, consistency of performance is a good indicator to the quality of a scheme. Also bear in mind that not all schemes in the same category may use the same benchmark so be careful when just evaluating based on alpha.
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Exit Load
Exit load is a cost that an investor needs to bear if he or she sells the mutual fund units before a predefined time frame. Typically, equity mutual fund schemes levy an exit load of 1% if the units are sold within one year of buying. Simply put, it is a mechanism to deter investors from premature withdrawals.
SIP
A SIP is an investment route where a fixed amount is deducted from your bank account every month on a specified date and invested in your chosen fund or mutual funds. The two biggest advantages a SIP offers is the convenience factor as it is an automatic investment of a fixed amount as well as Rupee Cost Averaging. Rupee cost averaging helps an investor deal with market volatility as when stock prices fall, SIP allocates an investor more units and allots lesser units when they rise thus, averaging out his/ her investment.
Fact Sheet
A Fact Sheet is an extremely useful tool when making an investment decision. Put simply, a fact sheet is a document published by fund houses which gives an overview of their various schemes. Each fact sheet has at least 1 or 2 pages dedicated to each scheme offered by the fund. The information contained in the fact sheet includes data such as the nature of the scheme and its investment style, its historical performance, the top holdings of the scheme and their respective weights in the portfolio and also data such as standard deviation and the benchmark used by the fund etc. Fact Sheets are regularly published by a fund house on their website every month.
It is very important before making an investment decision to read the fact sheet. This will help you gain a better understanding of the scheme and whether it is or isn’t a suitable investment.
In the next article we shall look at some important decisions we must make when investing in Mutual Funds, and also certain good investment practices.
Read also:
A Beginner’s Guide to Mutual Funds and Why You Should Consider Them
Different Types of Mutual Funds and What They Mean for Investor
