An equity fund or stock fund is a mutual fund that invests mainly in stocks and can be managed both actively and passively. It invests pooled amounts of money in public company stocks. Managers of equity funds use different methods to choose stocks while making investment decisions for their portfolios. While some fund managers use a value approach to stocks by searching stocks of companies that are undervalued in comparison to other similar firms, others choose them in terms of growth of a fund. In the latter method, stocks that are growing faster than their competitors or the market as a whole are chosen.
There is yet another class of fund managers who buy both kinds of stocks and build a portfolio of both growth and value stocks. Since equity funds invest in stocks, they are potentially high-returns yielding funds but carry greater risks at the same time.
Choosing an equity fund: comparison matters
A key basic of benchmarking is the evaluation of funds within the same category. For instance, if prospective investors are assessing the performance of information technology (IT) based fund, they should first compare its performance with a similar IT based fund. Comparing it with funds from another sector like the banking sector will not provide the accurate picture. Comparing a fund over a stock market cycle (highs and lows) can also provide investors a good understanding about how the fund has performed.
Compare returns against a benchmark index
Every fund provides a benchmark index in the Offer Document. In the case of India, these benchmark indices could be BSE 100, BSE 200, Nifty or other indices. Both the fund manager and the investor can rely on the benchmark index as a guide post and compare the fund’s performance against the benchmark index over a period of three to five years. Funds that have performed better than their benchmark indices during stock market volatility deserve a closer look. Investors should also evaluate the fund’s historical performance for getting an idea about consistent performers.