As a mutual fund investor, we examine many aspects before investing in mutual funds. Such as past performance of mutual funds, fund portfolio, fund manager etc. But we do not pay special attention to Mutual Fund Ratios. An investor usually looks at the parameters of the returns only with the objective of making maximum return on the amount invested.
Almost all types of investments come with some degree of risk. If your returns are not proportional to the risk of that investment, then this investment will not be of much benefit to you. A Best Mutual Fund is the one that gives the highest return among funds of equal risk.
Now this question must be coming in your mind that we can measure the returns of any funds but how to determine or measure the risk of any mutual fund.
But there are some ratios related to mutual funds, with the help of which you can measure the risk or volatility of a mutual fund portfolio. With the help of these ratios, you will not only be able to choose the best mutual fund scheme for yourself, but you will also be able to compare funds between them.
Table of Contents
Alpha Ratio
Alpha Ratio in Mutual Funds- Alpha Ratio is an important parameter to test a fund. Usually every mutual fund scheme has a benchmark index. The Alpha Ratio of a fund tells us how a mutual fund has performed against its benchmark.
For example, SBI Bluechip fund’s benchmark is S&P BSE 100 TRI and this fund has an Alpha of 1.50%. This means that this fund has given 1.50% higher returns than its benchmark.
If the Alpha remains at 1.50%, then it would be considered that this mutual fund has given less return of 1.50% than its benchmark. Here if the benchmark has given a return of Rs 100, then the return of fund here will be Rs 98.5 only.
Thus, Alpha return is what a mutual fund scheme earns over and above its benchmark. You must have ever heard from an expert or individual that this fund has outperformed its benchmark index. Here the out performance is related to the Alpha ratio. High Alpha is always considered good for any fund. While selecting Mutual Funds, you can exclude funds with negative Alpha.
- Alpha is also considered to be the fund manager’s value, indicating additional returns from the benchmark.
- The base of Alpha is considered to be “0” (zero). If alpha is “0” then it is considered that the fund is performing exactly in line with its benchmark.
Alpha Ratio Formula
The Alpha ratio can be found through this formula.
α = RP – [RF + (RM – RF ) ß]
Here-
- α = Alpha
- RP = Realized Return of Fund
- RM = Market Return
- RF = Risk-Free Rate
- ß = Beta
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Beta Ratio
Beta Ratio in Mutual Funds- Beta is directly related to the market movement. This ratio shows the relationship of a mutual fund scheme to the volatility of the market. Beta’s benchmark is always assumed to be 1. That means, “1” is the ideal beta ratio.
Suppose the Beta Ratio of a fund is 1.20. In this case the fund will increase or decrease by Rs 1.20 for every Rs 1 market rise or fall. This fund is giving 20% more returns than its benchmark. This fund will also be more risky as it has the potential to give higher returns.
Funds with Beta more than 1 are considered more risky due to being more volatile.
Similarly, if the Beta of a fund is 0.70 then it will be a fund giving less return than its benchmark. As the benchmark of this fund has given a return of Rs 100, then this fund will give a return of Rs 70 only. If the benchmark breaks below Rs 100, then this fund will see a fall of only Rs 70. Thus Mutual Funds with low beta ratio may compromise on the returns but these funds carry less risk. Market volatility does not affect them much.
Investors with low risk appetite can definitely invest in mutual funds with low Beta.
Beta Ratio Formula
Beta = Covariance / Variance
Sharpe Ratio
Sharpe Ratio in Mutual Funds- Sharp Ratio is named after William F. Sharpe. Sharpe Ratio is usually used to compare two mutual funds of the same category. By looking at the Sharpe Ratio of any fund, you cannot guess whether that fund is good or bad.
Sharpe Ratio uses SD (Standard Deviation) to measure the Risk Adjusted Return of Mutual Funds. This ratio tells you how your fund has performed apart from the risk free returns. Risk free returns are derived from government securities and bonds. This ratio gives you an idea whether your higher returns are due to taking more risk. That’s why it is considered good to have more Sharpe Ratio.
It is used to measure the return offered by the fund against the risk taken by the investors.
Suppose ABC Mutual Fund and XYZ Mutual Fund are different funds of the same category. Both these funds have given returns of 15%. ABC Mutual Fund has a Sharpe Ratio of 1.25 and XYZ Mutual Fund has a Sharpe Ratio of 1.00. Here you will not be able to decide which mutual fund is good on the basis of returns. Here the Sharpe Ratio of ABC Fund is more than that of XYZ Fund, then ABC Fund will be considered better among these two. Because ABC Mutual Fund is giving you high returns at low risk.
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Sharpe Ratio Formula
Sharpe Ratio = RP – RF / σ
- RP = The Expected Returns on Investor Portfolio
- RF = The Risk Free Rate of Return
- σ = The Portfolio Standard Deviation, A measures of Risk
Standard Deviation Ratio
SD Ratio in Mutual Funds- SD Ratio gives a range of performance of any mutual fund. Range means the maximum and minimum returns the fund can give. SD measures the volatility of a fund’s returns in relation to its average returns. This ratio tells you how much the fund’s returns can differ from its historical average return.
You can understand Standard Deviation Ratio with the help of this example.
Let the Axis Bluechip Fund’s Average Rate of Return is 15% and its standard deviation (SD) is 3%. So what will be the return range here?
Maximum Return- 15% + 3% = 18%
Minimum Return- 15% – 3% = 12%
Thus, the range of returns of this mutual fund will be between 12 to 18%.
Lower SD Ratio will reduce the range of the fund and due to which there will be less volatility in the fund and consequently the fund will be less risky. The higher the SD Ratio, the greater the range of the fund, which will lead to higher risk and volatility in the fund.
Therefore, the lower the standard deviation, the better it is considered.
Where to get information about Mutual Fund Ratios?
You can get information about all Mutual Fund Ratios from the website of Value Research and Money Control. You will get information about all important Mutual Fund Ratios here.
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Conclusion
While choosing a mutual fund, you must see all the mutual fund ratios given above. This will enable you to choose a good mutual fund.
