Understanding Mutual Fund Ratios Is Essential Before Choosing A Fund

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Understanding Mutual Fund Ratios Is Essential Before Choosing A Fund
Himali Patel - 31 July 2019

Today there are multiple ways an investor can analyse mutual funds. However, it is a fact, that even the best performing mutual funds changes from time to time. This often questions investors’ existing method to research and select a good fund.

Although factors like risk appetite, time-frame of investment as well as investor’s objective are equally important, an in-depth understanding of certain ratios can help investors choose the best fund that can yield substantial results.

Here’s a look at the mutual fund ratios that investors need to understand:

Standard Deviation: The component of standard deviation measures the volatility of a fund’s returns in relation to its average. It indicates how much your fund’s return can deviate from the historical mean return of your scheme. A higher standard deviation implies a greater volatility, whereas a lower standard deviation is better for investors’ experience. Market experts said if a fund has average rate of return of 12% with standard deviation of 4%, then your return would range from 8-16%.

Beta: Beta is the measure of volatility or systematic risk of the stock/mutual fund in comparison to the market as a whole. Simply put, it measures a fund’s volatility compared to that of a benchmark. For example, if your fund has a beta of 0.75 and the benchmark of the fund rises by 1% then the fund will also go up by 0.75% and fall by 0.75% in case if the benchmark goes down by 1%. Beta greater than 1 implies investment's price will be more volatile than the market. Again, lot depends on investors risk profile while deciding whether to go for high beta or a low beta. Industry experts believe that a low beta portfolio tends to perform better as compared to high beta portfolio.

Alpha: An Alpha is what any investors seeks to create that excess returns over the benchmark. Simply put, Alpha is an excess return on your investment when compared between a fund’s actual returns and its expected performance. However, it is a job of a fund manager to create that excess on a risk-adjusted basis.

Sharpe Ratio: Sharpe ratio indicates what return is earned at the level of risk taken by the fund. A higher Sharpe ratio for the investors means a higher risk-adjusted return. One important factor which differentiates Alpha from Sharpe ratio is that although Alpha indicates excess returns on a risk-adjusted ratio, however it considers benchmark as a measurement to gauge performance.

R-Squared: The component of R-Squared measures the relationship between a portfolio and its benchmark, where usually values range from 0-100. As per industry experts, a mutual fund with an R-squared value between 70 and 100 has a good performance record that is closely correlated to the index. However, a fund rated between 40-70 falls under average portfolio returns and less than 40 or less typically means the portfolio’s returns does not perform like the index.

If you are an aggressive investor and looking to investing in mutual funds, do remember to have a proper understanding of the above ratios.

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