What is Alpha and Beta in Mutual Funds? Calculation & Other Ratio

It’s important to remember that trading involves risk, and no strategy can guarantee profits. Always use caution when trading and consider consulting a financial advisor or professional before making any investment decisions. In simple terms, Standard Deviation is a statistical measure representing the Volatility or risk in an instrument. It represents the degree of spread or deviation of a set of values from their mean or average. SD tells you how much the fund’s return can deviate from the historical mean return of the scheme. The right mutual funds for your long-term goals with inflation-beating growth plus risk management.

Standard Deviation – Is the average deviation from the mean returns. It’s an indication of volatility i.e. deviation from mean returns. You shall not assign your rights and obligations under this Agreement to any other party. The Website may assign or delegate its rights and/or obligations under this Agreement to any other party in future, directly or indirectly, or to an affiliated or group company. The Website reserves the right to discontinue or suspend, temporarily or permanently, the facilities. You agree that the Facilities Provider/ ABC Companies will not be liable to you in any manner whatsoever for any modification or discontinuance of the facilities.

Understanding the types of Mutual Funds

Update your mobile number & email Id with your stock broker/depository participant and receive OTP directly from depository on your email id and/or mobile number to create pledge. A zero Alpha is not necessarily bad, especially in the scenarios when Large Cap Equity Funds are facing a tough time to beat the Nifty 50 index. Risk can be defined as the unfortunate possibility of losing a part of or all of the original investment. Risk can arise from several sources such as changes in the interest and currency rates, inflation, economy, industry, political situation and dozens of other internal and external factors.

So, if the benchmark index moves up by 5%, the scheme will also deliver 5% returns. If a mutual fund scheme has a beta of 2, it means if the benchmark index moves up by 5%, the scheme will deliver 10% returns. Conversely, if the benchmark index falls by 5%, the scheme’s net asset value will fall by 10%. In this article, we will look at risk measures used in analysing equity and debt mutual funds portfolios.

Key situations and errors to be avoided by investors

For periods of more than 1 year, you need to annualise returns; which means you need to find out what the rate of return is per annum. CAs, experts and businesses can get GST ready with ClearTax GST software & certification course. Our GST Software helps CAs, tax experts & business to manage returns & invoices in an easy manner. Our Goods & Services Tax course includes tutorial videos, guides and expert assistance to help you in mastering Goods and Services Tax. ClearTax can also help you in getting your business registered for Goods & Services Tax Law.

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Fortunately, there are ratios that already exist and calculate the risk and volatility of any mutual fund portfolio. This will not only give you a better understanding of risk and volatility, but also help you choose a better fund when you are looking at various mutual fund offer documents. Let us take a look at some key tools or ratios that measure this risk.

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Standard deviation is a statistical tool that measures the deviation or dispersion of the data from the mean or average. When seen in mutual funds, it tells you how much the return from your mutual fund portfolio is straying from the expected return, based on the fund’s historical performance. For example if the portfolio XYZ has a standard deviation of 7% and average return of 15%, it means that it has a tendency of deviating by 7% from its expected average return and may give returns between 8% to 22%.

In other words, it represents the risk-adjusted return of an investment. There are several other measures or methods instrumental in gauging a fund’s performance, namely Standard Deviation, Sharpe Ratio, P/E Ratio, and R-Square. These measurements, along with alpha and beta are employed to determine which fund is statistically performing better compared to its peers. Measuring standard deviation will help the investors see how consistent the rate of return has been over a time period.

Match Risk Level-

This brings us to the question, how exactly can you measure a fund manager’s contribution to performance? It is the difference between the return you would expect from a fund, given its beta and the return it actually produced. If the fund returns more than its beta would predict, it has a positive alpha and if it returns less than the amount predicted by the beta, that would mean that the fund has a negative alpha. Thus, the wider the spread of the data, the higher is the standard deviation. Standard deviation is one of the key measures in assessing the risk by portfolio managers and investment advisors. A high dispersion indicates the high deviation of the return from the expected mean value.

The accuracy of the data rests in the size of the data set, i.e. the larger the data set, the more accurate the standard deviation is. Furthermore, while you will solely arrive at a number using this specific deviation definition for risk calculation, there is always a problem as to whether it is low or high. It has meaning only if it is compared to funds in the peer group.

Since markets are volatile, the returns fluctuate on a daily basis. These fluctuations depend on various internal and external factors. A risk-adjusted return involves the calculation of returns generated by a mutual fund scheme that factors in the amount of risk taken to achieve it. Calculation of the risk-adjusted return helps an investor understand whether the risk that they are taking is worth the expected return. Beta is the most commonly used risk measure that calculates the volatility or systematic risk of a security or Mutual Fund’s returns as against its benchmark. In other words, Beta shows the sensitivity of a mutual fund portfolio towards the market.

Financial advisors and investors use this data to gauge a specific fund’s volatility. 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.

Volatility is not the same as risk, but it is an anticipation or reaction to a risk event. A highly volatile fund poses greater risk to the investor than a fund with lower volatility. Volatility in the market provides the investors an impression that they are losing out on money, but that is not necessarily true. Being reactionary to the volatility in the market can prove to be detrimental to the investors interest in the longer run. Market volatility is usually measured with the help of beta ratio and standard deviation.

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Where Variance is the average of the squared deviations from mean returns. Standard Deviation in Mutual Funds will tell you how risky is particular fund. While choosing a Mutual Fund – Return is not the only criteria; we have to check Risk-Returns, Tax, Inflation, Liquidity, etc. There are few more scientific formulas that help one to choose funds – we will be covering them at some later stage.

• WIth this, you can take a more informed decision regarding the funds you want to invest in.
• You are therefore advised to obtain your own applicable legal, accounting, tax or other professional advice or facilities before taking or considering an investment or financial decision.
• Investors opt to invest as per the alpha ratio in Mutual Funds around 1.5.
• The standard deviation allows you to measure the variability in the performance of a mutual fund.

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Thumb Rule: Higher the Standard Deviation of Mutual Fund – Higher the Volatility.

Low-risk schemes such as debt mutual funds tend to have a low standard deviation. While funds in the equity category will have a higher standard deviation in comparison to the debt category. A standard deviation is a statistical tool that helps measure the deviation in portfolio returns from its average. The standard deviation has wide use in determining the risk of an investment. It is an important metric to consider while investing in market-linked instruments.

For example, XYZ Mutual Fund Scheme has the Nifty 50 Index as the benchmark. The Nifty 50 Index went up by 12% in a particular year, and XYZ Mutual Fund Scheme went up by 15%. So, the alpha is the additional return of 3% generated by the XYZ Mutual Fund Scheme compared to its benchmark .

One of the most vital considerations while investing is the risk profile of the asset or security you’re interested in. For instance, if you are about to invest in a mutual fund, then it’s necessary to check the risk profile of the scheme you’ve selected for your investment. You should only proceed if the risk level of the scheme matches your risk appetite. We can see that the Sharpe ratio of the HDFC top 100 plan is higher, and the fund provides lesser returns per unit of this volatility at 0.32. Whereas Kotak Bluechip is not only less volatile but also generates more returns per unit of volatility at 0.47. Similarly, HDFC Top 100 is more sensitive to market movements with a higher beta, and a negative alpha implies that the fund may not have been able to keep up with the category returns.

If you can relate to this, then these what is standard deviation in mutual funds will help you understand the nuts and bolts of your fund. A key point to remember with regards to both Beta and Alpha is, both of these measures rely on historical data and change from time to time. Therefore, funds can either have a positive or a negative Alpha, and this depends on how well the fund manager runs the fund. For instance, if the fund’s beta is 0.85, it is less sensitive to the benchmark compared to 1.10 which is more sensitive. In other words, in the former scenario, with every rise in the market by 1, the fund will rise by 0.85, and if there is a fall, the fund will fall by 0.85. What you need to take out of this is that the fund with the lower standard deviation would be more optimal because it is maximizing the return received, for risk acquired.