How to Choose a Mutual Fund?

Given the many advantages mentioned, mutual funds have become one of the most popular investment instruments for the public in the capital market. Their wide variety is reflected in over 2,000 mutual funds of all types, across various investment channels and risk levels, offered in the Israeli capital market. To facilitate selecting the most suitable mutual fund for an investor, we have compiled the key parameters we believe are important to consider:

Investment Objective and Suitability to Needs

The first step is to specify the investment amount, the purpose of the investment, and whether it is for the long or short-to-medium term. It is also important to set the investment’s risk level – some investors are willing to take relatively high risks while others prefer safer investments, even at the expense of lower returns.

Once the investment objective and risk level are set, an investment mix can be built, determining the exposure to different channels.

Alignment with Investment Policy

It is advisable to ensure that the fund’s investment policy aligns with the investor’s desired exposure and risk levels. The nature and investment policy of each fund are published in the fund’s prospectus, annual statement, and dedicated reports.

Fund Performance

To make an investment decision, the investor should examine two main criteria: return and risk level.

• Return – The most common way to evaluate a fund’s performance is to compare its return to the benchmark index and similar funds over the same period. Investors should keep in mind that the longer the period the fund’s performance is examined, the better its management quality under varying market conditions is judged. It is important to note that past returns do not guarantee similar future returns.
• Risk Level – The risk level of an investment in a mutual fund is measured using various indicators, with the most common being standard deviation and the Sharpe ratio:
• Standard Deviation – A metric that describes the volatility of the fund’s returns. The higher the standard deviation, the greater the investment risk.
• Sharpe Ratio – Reflects the relationship between return and risk: the higher the return relative to the risk, the higher the ratio. Thus, if two funds achieve the same return, the fund with the lower risk will have a higher Sharpe ratio.

Mutual Fund Ratings

Many mutual fund investors rely on the services of investment advisors in the process of building their investment portfolio and selecting the most suitable funds.

Investment advisors at various banks use different rating systems developed over the years in each bank, which serve as a key tool for selecting the fund to include in a client’s portfolio. These rating systems effectively combine the fund’s return with its inherent risk level.