In the financial market, Mutual fund investments are charming products. So, while deciding or comparing any MF one should never only compare the return. There are few other risk parameters which should also be taken into consideration. Few of them are listed and explained below:
Alpha
A figure of 0 in the case of alpha is indicative of an asset manager’s performance graph to be precisely in line with the benchmark index. Any number in the negatives would suggest the asset manager’s performance as underwhelming. Further, alpha in mutual funds beyond 0 showcases the fund manager’s achievement of outperforming the benchmark index. The baseline for alpha in Mutual Funds is 0.
For example: if an asset manager can reap a 10% return on a specific Mutual Fund against a benchmark index of 8%, his/her alpha ratio would be 2. Investors opt to invest as per the alpha ratio in Mutual Funds around 1.5. Note that the alpha ratio in Mutual Funds should be considered based on a mean of previous performance and not just on current data.
Beta
The baseline for beta in Mutual Funds is 1.In case of beta, value 1 suggests that a specific fund responds to market volatility equivalently, i.e. the shift in its price is equivalent to the benchmark movements. A value above 1 represents that a specific fund demonstrates a more significant shift in its price compared to benchmark movement. A value below 1 represents the opposite.
For Example: The beta ratio of a specific Mutual Fund is 0.7 or 70%; it means the fund is 0.3 or 30% less volatile than the benchmark index. A Beta ratio value of 1 indicates a lower risk and lower growth potential compared to ratios at par or above 1. Investors with a low-risk appetite would always prefer a lower beta ratio in Mutual Funds as it indicates a steadier response to a volatile market condition. Similarly, investors with the investment objective of higher returns would prefer beta ratios of 1 or more than 1.
Standard deviation
It is used to measure the variation of a set of data from the mean or average. In the case of Mutual Funds, the standard deviation indicates the digression of Mutual Fund returns in different phases of the market from the average or mean as calculated prior. Financial advisors and investors use this data to gauge a specific fund’s volatility.
Sharpe Ratio
It is used by investors to measure the return provided by a fund in comparison to the risk it carries. The process of calculating the Sharpe ratio includes deducting the risk-free rate from the mean figure. Simply, it helps analyse the profits earned from varying degrees of risk. In other words, it represents the risk-adjusted return of an investment.
P/E Ratio
Price earning Ratios or PER represents how much a single unit of a fund can earn and what price is to be paid for that unit. It is the ratio between the current price of a single unit of a fund and the earnings per share of it.
R-Square
It indicates the percentage of fund returns that conform to the movements in the existing benchmark index. In principle, this method is the closest to alpha and beta ratios. R-square ratio figures lie somewhere between 0 and 1. The value 0 suggests that there is no percentage of funds in a portfolio that reacts to movement in its respective benchmark index; whereas the value 1 represents that change in the benchmark index mirrors the movements in fund returns.
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