Thread by @Finalysis20

What is an important pre-requisite before investing in a mutual fund?

Understanding the asset class.

Infact it is paramount in any investment.

What exactly is an asset class?

Let's understand it in detail.

A thread 🧵

What is an asset class?

Asset class is the actual investment type wherein your money will be invested.

Examples:
~ Gold
~ Equity
~ Real Estate
~ Corporate debt
~ Government securities

The performance of the asset class would decide the mutual fund's return.

What should you understand in a asset class?

~ Risks involved
e.g. Equity has market risks
Corporate debt has risk of default

~ Duration of holding
e.g. Equity requires 5-10 yrs of holding period

Govt securities like treasury bills have as less as 90 days of maturity period

Understanding an asse class

Volatility:

To know fluctuations in invested capital
e.g. Equity is volatile, however mid caps have higher volatility than large caps!

~ Return expectations
Equities cab provide 10-12% return, but a govt security's interest could be lower than FD.

Why duration is important while understanding asset class?

Suppose, you want to redeem your investment in 2yrs.

Then neither equity (holding duration 5-10yrs) nor govt security (holding duration 3-9 months) would be suitable.

Corporate debt could be the right choice!

What to look in a Equity asset class?

~ Type of stocks held
e.g. large cap, small cap, mid cap, IPOs, sector specific

~ Sectoral weightage
% allocation to finance, pharma, IT, FMCG etc. sectors

Returns would be skewed if the fund is overweight on certain sector

What to look for in debt asset class?

~ Credit rating of debt instruments held

Mutual fund disclose the % allocation to debt securities based on their credit rating.

A rating above AA is considered safe. Higher allocation to low credit rated debt securities means higher risk!

What to look for in Government securities?

~ Maturity period

Govt securities typically have 45days, 90days, 180 days or 9 months maturity period

Higher the maturity period more is the return.
However, chances of interest rate risk increases with duration.

To summarise:
Each asset class:
~ Has different risks
~ Has it's own minimum period to realise it's return

Returns of each asset class vary based on the nature of underlying instrument!