You may have seen or noticed commercials of Mutual Fund Schemes that end with a standard disclaimer – ‘Mutual Fund investments are subject to Market Risk. Past performance may or may not be sustained in future. Past performance is not indicative of future returns.’
The two terms which are important here are ‘Returns’ & ‘Risk’ (or Volatility).
A mutual fund scheme invests in Equity and/or debt securities. These are the underlying assets of a mutual fund scheme. The returns generated by these securities can be VOLATILE.
So, when picking the right and best mutual fund scheme, it is advisable to
- To analyze the past performance of the funds (measure returns) & also
- To evaluate how VOLATILE these returns are? How consistent are the returns?
The volatility of returns generated by a mutual fund scheme can be measured by some important risk ratios like;
- Standard Deviation
- Beta
- Alpha
- Sharpe Ratio
- R-Squared Ratio
- Upside & Downside Ratios
Actually, these ratios are referred to as ‘measures of Risk’. But, they measure the volatility associated with a financial instrument. This volatility leads to RISK i.e., you may or may not get the desired returns to achieve your financial goal(s).
When short-listing the best mutual fund scheme, you can analyze the funds on four parameters;
- Compare the returns generated between Fund A and Fund B.
- Analyze and evaluate the volatility of returns between Fund A & Fund B based on measures of Risk.
- You can also compare returns of Fund A with the returns of its Benchmark index / Fund Category.
- You can evaluate the measures of Risk between Fund A with that of its Category or Benchmark index.
How to select the best Mutual Fund Scheme based on Measures of Risk/Volatility?
Let’s now discuss more details about these ratios and try to understand their importance when selecting the right and best mutual fund scheme. You need to give importance to both returns and measures of volatility while short listing mutual fund schemes.
Standard Deviation
- Standard deviation for a mutual fund tells you how much variance there is in the fund’s returns.
- Based on SD you can analyze the consistency of returns generated by a mutual fund scheme.
- It’s useful in a long-term sense (longer time period).
- A Standard deviation of say 20 means that fund will generate plus or minus 20% from its long term average returns.
- If a fund has say a 12% average rate of return and a standard deviation of 4%, its return will range from 8-16%.
- Higher the Standard Deviation, higher the fluctuations in returns. So, you need to look out for a fund with a low Standard Deviation.
Beta
- Beta gives you an idea on the correlation between a fund’s performance and its Index.
- It tells you how much a fund’s performance would swing compared to a benchmark. (SEBI made it mandatory for fund houses to declare a benchmark index. For example: The benchmark index for HDFC Top 200 is S&P BSE 200.)
- High Beta or low Beta, which one is good? If you are a risk-averse investor, low Beta is good. High Beta does not mean the fund’s performance is better than its index. It just indicates that returns can be volatile (up or down) when compared to the fund’s benchmark index.
- If a mutual fund has Beta of 1 that means the performance of the fund will perfectly match the performance of its benchmark index.
- If a fund has a beta of 1.5, it means that for every 10% upside or downside, the fund’s NAV would be 15% in the respective direction.
- The Beta can be a negative figure too, which indicates that there is no correlation between the performance of fund and its benchmark index.
Alpha
- Alpha gives you an idea whether the fund has out-performed its benchmark index or not.
- It measures the fund’s performance (returns) and risk relative to its benchmark index.
- Alpha is measured as a percentage so an alpha of 10 means the fund outperformed its benchmark by 10%.
- So, ideally you would like a fund to have HIGH Alpha. Higher the Alpha the better.
R-Squared Ratio (R2)
- R-Squared measures the relationship between a portfolio and the Fund’s benchmark.
- Kindly note that it is not a measure of the performance of a portfolio. However, it measures the correlation of the Fund’s Portfolio’s returns to the Benchmark’s returns.
- Most of the Large cap & Index funds will have high R-Squared ratio.
Sharpe Ratio
- It measures the returns with respect to risk taken by the Fund. It is a risk-adjusted measure.
- A good Fund should be able to generate decent returns without taking too much risk.
- Ideally, a fund with high Sharpe Ratio is better. (Treynor ratio is similar to Sharpe Ratio.)
Upside & Downside Capture Ratios
- These ratios show us whether a given fund has outperformed i.e., gained more or lost less than the broad market benchmark during periods of market strength (bull phase o upside) and weakness (bear phase or downside), and if so, by how much.
- An upside capture ratio of over 100 indicates a fund has generally outperformed the benchmark during periods of positive returns for the benchmark. Meanwhile, a downside capture ratio of less than 100 indicates that a fund has lost less than its benchmark in periods when the benchmark has been in the red. (courtesy : mornigstar.com)
- Ideally, you would like a fund to have higher Upside capture ratio (>100) and lower downside capture ratio (<100). Lower the downside capture ratio, better the ‘DOWN-SIDE PROTECTION’.
- Some funds may give you the best returns when markets are UP but they do not necessarily go on to out-perform when the markets FALL. So, we need to identify the funds which outperform in both the scenarios. Identifying the funds that ‘lost the least when markets tanked’ should also be given importance.
- Capture ratio is calculated as Upside Ratio divided by Downside ratio. For example, a fund with an upside-capture ratio of 100% and a downside ratio of 80% would have an upside/downside ratio of 1.25. Any ratio above 1 means that a fund does a good job of capturing gains during bull phases while lessening the impact of bear markets.
There are certain other Risk ratios like;
- Sortino Ratio : It is a variation of Sharpe Ratio. It factors in only the downside or negative volatility.
- Omega Ratio : The Omega ratio is a relative measure of the likelihood (probability) of achieving a given return, such as a minimum acceptable return or a target return.
Where to get information on important Measures of Risk Ratios?
Where to find the values of these Risk Ratios? Are there any online portals which provide details on these measures of risk?
Yes, the details are readily available on portals like Valueresearchonline & Morningstar.
How to Compare Mutual Funds Performances based on Risk Ratios? (Fund A Vs Fund B)
- You may click on ‘Returns’ tab to analyze the Funds’ performances.
- You may click on ‘Risk Stats’ tab to evaluate the performances of these funds on various Risk ratios.
Fund A Vs Benchmark Index Vs Fund Category
- Click on any individual Mutual Fund Scheme link and you can find details about risk ratios related to that specific Fund, its Benchmark Index and also of Fund Category in the same table. Below details are for SBI Blue Chip Fund Vs S&P BSE 100 (its benchmark index) Vs Category (Large-cap).
You may also find risk ratios’ details in Morningstar portal.
- Visit Morningstar.in portal and click on ‘Tools‘ menu option.
- You may click on ‘Fund Risk Measures’ to know the details of Risk ratios of a Fund. You can click on ‘Category Risk Measures’ to evaluate the category wise measures of volatility.
- Below details are for SBI Bluechip Fund (Click on ‘Fund Risk Measures’) (Morningstar provides information on Capture ratios, but the benchmark index for all the comparisons is S&P BSE 100)
Conclusion:
Performance (Returns) is not everything. If a fund generates high and abnormal returns but takes too much risk (unwarranted) then the returns may plummet (or) the performance may not be consistent. So, as a mutual fund investor you would like to invest in a product which balances risk and returns.
It is prudent to analyze both returns and risk ratios before shortlisting the best Mutual Fund Schemes.
Do you evaluate your MF Schemes based on these measures of Volatility? Kindly share your views and comments. Cheers!
Continue reading :
(Image courtesy of Stuart Miles at FreeDigitalPhotos.net. References : Valueresearchonline, morningstar & Freefincal.com) (Post Published on : 23-June-2016)
This post was last modified on July 11, 2023 11:37 am
View Comments
Hi Sreekanth,
Firstly, let me thank you for putting up your valuable time in creating such a great website in terms of knowledge.
I am planning to invest in equity funds for 10+ years through SIP route 5k each per month in the below funds (ALL DIRECT PLANS)
1. Diversified - ICICI Prudential Value Discovery Fund
2. Diversified - Birla Sun Life Equity Fund
3. Large cap - Kotak Select Focus Fund
4. Small & Mid-cap - Reliance Small Cap Fund
would you recommend any changes in the above mentioned funds/ portfolio allocation?
In addition to the above SIP, i am also planning to invest in long term debt funds for about 3-5 years in
1. ICICI Prudential Long Term Plan (5L)
2. UTI Dynamic Bond Fund (5L)
or would you suggest liquid/ultra short term/arbitrage funds are better instead of long term debt funds?
Thank you
Dear Tapas,
Your portfolio has higher allocation to Large cap stocks, though there are two diversified equity funds.
You may pick one mid-cap fund, if you would like to build a slightly aggressive portfolio, else a balanced fund for a moderate portfolio.
You may go ahead with Dynamic funds, but do not that even debt funds are associated with some risks.
Read: Types of debt funds.
Hello Sreekanth,
I would like to invest in some good short term fund for the next 1 to 2 years.
Could you please help me choose between the following?
1. Indiabulls short term fund
2. baroda pioneer short term bond fund
Thank you.
Dear Chandan ..Kindly go through my article on, Best debt funds..
Hello Sir, I'm 30 yrs old earning 80k per month and investing 21k per month in MFs. i can further invest 4k more per month. please suggest me whether below portfolio is fine or need to change with any different fund in case i would have taken high risk by choosing below funds. My Goal is to build 50lakhs by next 10 yrs and 1 crore by next 15 years. Below are my portfolio diversification details ?
SIP Details as below(Monthly Basis)
ELSS
Axis Long term equity fund Direct Growth : 2000/-
Large Cap
SBI Blue Chip Fund Direct Growth : 3000/-
Mid Cap
Franklin India Prima fund Direct Growth : 3000/-
Small Cap Franklin India Smaller companies fund Direct Growth : 2000/-
Diversified
ICICI Prudential value discovery fund Direct Growth : 3000/-
Balanced fund
HDFC Balanced Fund Direct Growth(Equity based Balanced Fund) : 3000/-
Debt Fund
Birla Sun Life Short term fund Direct Growth : 5000
Dear Rajesh,
Suggest you to go through below articles & available calculators, to analyze your case.
Retirement goal planning & calculator.
Kid's education goal planning.
The portfolio looks fine.
Hello,
I want to invest 85000 in sector fund for 3-5 years. I am looking for pharma sector of reliance. I compared SBI , UTI and TATA pharma but distribution of reliance looks good.
Can you suggest is it good choice or not. I know pharma not performing well last 2 years.
I want to do STP of big chunks rather small SIP or lump sum to achieve good NAV.
Dear Swapnil,
Do you have any existing mutual funds in your Portfolio?
Hi Sreekanth,
AGE is 32 My goal is to have retirement corpus around 2.5 crore. I have investment vision of 20 years. Current 2-SIP started in last month of 3000/- each, Can invest upto 10000 more. BSL frontline (3000) SIP HDFC Tax saver (3000) SIP I have already large cap portfolio so I think I should create mid-small cap sip and one sector sip. I am looking for reliance pharma mutual fund. Please suggest your opinion.
Thanks, Swapnil
Dear swapnil,
Kindly go through this article : Retirement goal planning & calculator.
Small/Mid-cap suggestions : Best Equity mutual funds list.
Kindly note that generally investments in sector fund can be associated with high amount of risk. So, if you understand and aware of them, you may go ahead and allocate a small portion of your investible corpus to sector fund.
Thank you Sreekanth.
hii sir,
i m planning to invest in mutual funds and i new to this markets i dont have any idea about it and i want to invest for a short period say 1 year or 18 months kindly suggest me & guide me best mutual fund script to invest thanking you in advance
Dear Pooja,
Ok. May I know your investment objective?
hii sir,
my investment objective is not much defined i require funds for my sisters higher education that is after 1 or 1 1/2 year
Dear Pooja,
If you need this money after around 12 months from now, suggest you not to invest in Mutual funds.
You may consider traditional options like Bank FDs/RDs.
Kindly read:
What are Debt funds?
List of investment options.
HI, I HAVE SOLD A SMALL PROPERTY FOR 30 LAKHS I WANT TO INVEST IN MUTUAL FUND WITH EVERY MONTH PAYOUT, AND TO RE INVEST THIS PAYOUT IN MIDCAP FUNDS (G) FOR BEETER RETURNS.
NEED YOUR HELP TO TELL ME THE PLAN ABOVE I AHAVE MADE IS GOOD OR BAD?
Dear MMP,
May I know your investment objective and time-frame?
Instead of reinvesting the payout, isn't better to invest the amount directly in the Funds of your choice based on your financial goals????
Kindly read: Best Equity funds to invest in 2017-18.
Hi There,
I am 29 years old and am currently investing towards multiple goals (3+ years, 5+ years and 10+ years) with the following monthly SIPs-
SBI BlueChip- Rs. 6000
ICICI Value Discovery- Rs. 4000
Franklin Smaller Cos- Rs. 4000
DSPBR Microcap- Rs. 4000
I also invest in ELSS- Axis and Franklin- total of Rs. 50,000 per year, with a PPF contribution and going to start a Term Insurance this year.
Now, I am also planning to start investing in a Balanced fund. I am confused between HDFC Balanced and ICICI Balanced. ICICI Balanced has huge overlap with ICICI Value Discovery but is a better fund from what I've come to know.
Below are my questions-
1. Can you please suggest if my overall portfolio is good enough or do I need to cut any particular fund?
2. Which balanced fund would you recommend based on my current portfolio and goal horizon? Do I even need balanced fund?
3. Is HDFC Click2Protect a good Term Insurance Policy? Which policy would you recommend?
Thanks.
Dear Amit,
1 - I believe investing in 7 MF schemes may lead to over diversification. However, you can check portfolio overlap among these funds and decide, as all of the mentioned funds are good ones.
Read:
MF portfolio overlap analysis tools
My MF portfolio
2 - HDFC or SBI balanced funds can be considered.
3 - Read : Best online term insurance plans.
Hi sree!
Thanks for the article. really good.
sree is there any article on how mutual fund portfolio is rebalance or what is rebalancing.
Dear Abhee..As of now, I have not yet published ..will try to write one soon. Thanks for the post idea :)
Suggested articles:
How to Rebalance Your Investment Portfolio
How and When of Portfolio Rebalancing With Calculators..
Hello Mr Sreekanth Reddy,
I am a Govt Employee and have recently invested in 3 different MF's through SIP route. They are:
1)Kotak Select Focus Fund - 2K (growth)
2)HDFC Mid Cap Fund - 2K (growth)
3)UTI MNC Fund - 2K (growth)
I am willing to make my portfolio bigger by investing another 4K in the coming months in SIP. Please suggest if the investment made my me are good decision or not.
Moreover, I have long term plans like buying a house, childrens marriage, education and retirement planning. However, I am clueless how to go about investing and in what MF's should I invest in the future.
Another question I want to ask here is that I have around 9Lakh in Bank Deposit. 7.8 Lakh in FD and another 1.2 Lakh in Savings. The 7.8 Lakh FD attracts a lot of TDS so it is not a viable option. I want to withdraw 6 Lakh from my Deposit and invest in MF'
s. It is good according to you to invest the whole 6 Lakh as a lumpsump investment into 1 or multiple funds.
If it is good to invest lumpsump I am thinking of investing 3 Lakh into HDFC Prudence Dividend fund which pays out regular dividend. Also 3 Lakh into 1 or multiple Growth Funds. Which route according to you should I take as I am really confused where should I invest my hard earned money into.
My current monthly income is 30 K and 7.5 k every month gets invested in various LIC policies.
Thanks & Regards,
S. Kumar
Dear S Kumar,
May I know your age and time-frame of your Financial goals.
Kindly provide LIC policy details (Plan name, sum assured, tenure & commencement date).
Why would you like to get Regular dividends?
Suggested articles:
Financial planning pyramid..!
Kid's education goal planing & calculations.
Retirement planning Calculator.
List of important articles on Personal Financial planning.
Current Age: 34 Years
Time Frame: Kids Higher Education: In 20-25 years
Home: In 16-20 years
Childrens Marriage: 25years & 27 years (2 Kids)
Retirement Goals: 3Lakh/annum as per todays value after 26 years i.e., in 2042.
LIC Details:
1) New Money Back Plan (820), Tenure 20 yrs, Sum assured-150000, commencement date: 11/2/16,
2)Jeevan Tarun (834), Tenure 25 yrs, Sum Assured-820000, commencement date: 9/12/16,
3) Jeevan Mitra (133) Triple cover endownment, Tenure 15 yrs, Sum Assured: 200000, commencement date: 21/2/12
4) Jeevan Anand (149), Tenure 15 yrs, Sum Assured: 300000, commencement date: 12/11/11
Regular dividend plan in MF suggested by brocker and I am confused. So, I mentioned HDFC Prudence Dividend fund...
Dear S Kumar,
The existing life cover may not be adequate to you, also these are traditinal low yielding plans.
Suggest you to buy a Term insurance plan and you may discontinue these policies.
Read:
If life is unpredictable, insurance cant be optional.
Traditional life insurance plan - a terrible investment option?
Term insurance plan Vs Traditional plans.
Jeevan Tarun - review
LIC new money back plan - review
Best term insurance plans.
As your goals are long-term & objective is to accumulate wealth/corpus, kindly opt for Growth option instead of Dividend.
Dear Sreekanth garu, very nice article
Please advise me
Through mfuonline I have started investing in the following
Sbi bluechip 3k (large cap)
Sbi magnum multicap 3k
Franklin india flexi cap 3k
Principal emerging bluechip 3k
Dspbr micro cap 3k
I have horizon of 10+ years. I also save in ppf and nps(tier 1) I can go for moderately high risk category.
But after going through analysis of other fund schemes now I have doubts about my choices. Kindly guide me.
I have working spouse, Iam planning to invest from her side also, should the same schemes be chosen for her also?
Dear DC,
Your portfolio looks fine. You may retain one out of the two Mutli-cap funds (preferably SBI multicap). Franklin Flexi & SBI multicap are both diversified funds.
If both of your goals are same, you may pick same schemes.
Kindly read: MF portfolio overlap analysis tools.