Ace the NISM Mutual Fund Distributors ExamDifficulty: BeginnerInfo   5 min read
📌 Chapter 12.3 — Scheme Selection based on investment strategy of mutual funds

Consider a client who looks at their portfolio statement and asks why their large-cap active fund is trailing its benchmark by two percent over the last year. As an MFD, your immediate impulse might be to search for excuses, but the professional approach requires a rigorous evaluation of the fund’s active share and performance attribution. An active fund manager is paid a higher expense ratio specifically to deviate from the index in search of alpha.

If the manager holds a portfolio almost identical to the NIFTY 100, the high fee becomes difficult to justify, especially compared to the low-cost tracking of a passive index fund.

To evaluate this properly, you must look beyond point-to-point returns. Start by comparing the fund’s rolling returns against the benchmark over three and five-year periods, rather than just the recent quarter. If a fund underperforms in a bull market, investigate its defensive posture. For instance, a manager might be holding significant cash or moving into defensive sectors like FMCG to protect capital, which naturally leads to trailing the index during a sharp market rally.

This is not necessarily a failure of strategy; it is a manifestation of the mandate the investor agreed to when they bought into that specific category.

Distinguishing between a manager’s bad call and a deliberate tactical allocation is where an MFD earns their value. Use tools provided by the AMC to review the portfolio turnover ratio. A high turnover might suggest that the manager is chasing momentum rather than investing in underlying fundamentals. When you explain this to a client, you are moving the conversation from mere price fluctuations to the quality of the investment process.

This guidance during periods of relative underperformance prevents clients from redeeming in a panic, which is a core part of the behavioral support that justifies the regular plan expense.

Ultimately, every active scheme carries the risk of the manager failing to outperform the benchmark after accounting for the higher fees. Your job is not to find a fund that beats the market every single month, but to ensure that the chosen strategy aligns with the client’s risk appetite. If the manager consistently fails to deliver alpha despite taking significant risks, your professional judgment should lead to a portfolio review rather than blind loyalty to a brand name.

Nuance

⚠️ Nuance
Many candidates mistakenly believe that a fund with a higher expense ratio is objectively ‘worse’ for an investor. They often forget that the primary benchmark comparison must be adjusted for the fund’s specific investment objective, such as risk-adjusted returns or volatility. In professional practice, an MFD should never judge an active fund solely by its absolute returns, but by its performance relative to its peers and its specific stated benchmark.

Check Your Understanding

Practice Question 1

An investor complains that their active large-cap fund has underperformed the NIFTY 100 index by 1.5% over the last year. As an MFD, what is the most professional way to assess this situation?

Practice Question 2

Why is the ‘Active Share’ of a mutual fund an important metric for an MFD to monitor when comparing an active fund to its benchmark?

This is a companion read for Section 12.3 — Scheme Selection based on investment strategy of mutual funds from Ace the NISM Mutual Fund Distributors Exam by Akhilesh Gururani, available on Amazon Kindle.

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