Investors have a tendency to evaluate their mutual fund portfolio on the basis of the returns that it generates vis-à-vis benchmark returns.
However, for the diligent investor, it is not only the returns but also the risk involved with mutual funds that become important to gauge where the investments are headed. Below are some key statistical measures that help analyse mutual fund performance better:
Beta is an indicator of the volatility of a mutual fund’s return in comparison with the overall market index. By definition, the market index is given a beta of 1.0. If a fund has a beta of 1.10; it means that the fund moves up or down by 10% when the market moves up or down by 1%.
Correspondingly, if a fund has a beta of 0.95, it means that when the market moves by 1%, the fund moves less than the market. Thus, a higher beta fund while providing superior returns during a market up cycle may also fall more than the market when the cycle turns and is thus more risky.
R-Squared is a measurement of how reliable the beta number is, or it reflects the percentage of a fund’s movement that can be explained by its benchmark index. An R-squared of 100 indicates that all movements in a funds return can be explained by its benchmark.
In simple terms, it lets you know how similar a particular fund is to its given benchmark index. Thus, if you already have a Bank Nifty fund in your portfolio, you would not want to add another fund with an R-Squared of close to 100, since that would also perform just like your existing one. Instead, another fund with an R-Squared of much less than 100 will offer diversification.
This is an important measure of how well a fund performs adjusted for the risk undertaken. Since it takes into account the risk entailed in the fund investments, it helps investors gauge whether the returns from the fund are due to wise investments by the fund manager or due to a higher risk taken by the fund. Higher the Sharpe ratio is better.
This is a measure of how much a fund’s return deviates from its mean or average return over a period of time. In other words, it is simply a measure of volatility of the fund. A high standard deviation denotes high volatility of the fund. Funds with high standard deviation are generally not preferred, but, if the investor has the risk-taking capacity they may be considered.
Mutual funds charge fees by way of entry/exit loads which are generally paid directly by the investor. However, apart from these, they also incur expenses related to administration and management of the mutual fund.
Expense ratio measures the cost per unit of managing a fund and is not charged directly but deducted while calculating the Net Asset Value (NAV) of the fund on a daily basis. For funds with a similar return profile, expense ratios can help in comparison and selection. Expense ratios are more important over longer periods of time as high expenses may drag the performance of the fund.
With the applicability of capital gains and dividend taxes on mutual funds, this ratio helps measure the net returns for the investor – more taxes equal less net returns for an investor.
It must also be noted that these indicators must be evaluated in alignment with the fund objective, the risk-profile of the investor, and the time period of investment and are not to be considered in isolation for a proper health check of your investment.