Performance evaluation of mutual funds from the perspective of retail investor
Mutual Funds have become a very popular recently among the investors for participating in the financial markets in an easy, low-cost manner, while maintaining a risk profile suitable for each unique personality of the individual investor. It can play a pivotal role in an individual's investment strategy. With the huge number of mutual fund schemes available in the Indian markets, an investor needs to evaluate and consider various quantitative and qualitative factors before making an investment decision. There are a wide variety of matrices available to evaluate performance of a mutual fund from the fund manager’s perspective. However, the return enjoyed by the retail investor is often different than that showcased by the fund. The primary reason being the expense ratios and entry/ exit loads. This study is aimed at finding a measure of performance evaluation from the perspective of a retail investor. In doing so, I have studied in depth the widely popular performance tests like Sharpe ratio, Jensen alpha, Treynor ratio, M square measure and information ratio. All these measures have their own merits. However, the perspective of a retail investor is different from the fund manager and hence, needs to accommodate for the factors that directly affect him. While investing in the mutual fund, the investor already displayed willingness to undertake the systemic risk. However, he doesn’t want to undertake the non-systemic risk. Moreover, he would want to be compensated for every additional non-systemic risk undertaken by him through the mutual fund. Once a measure to evaluate the performance of a mutual fund after adjusting for expense ratio and non-systemic risk has been established, it is used to evaluate the performance of top mutual funds. This is relative measure and provides a relative ranking of mutual funds. The ranking of mutual funds obtained in this manner is then compared with other performance measures such as Sharpe ratio, Jensen alpha, Treynor ratio and information ratio to study if the ranking is consistent.