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
Dear Sir
I am new in this field want to invest for tax saving (Rs 10000) and better return plz suggest me which mutual fund would be good for me
Dear Punit,
May I know your investment horizon?
Suggest you to kindly go through below articles;
Best Equity funds for 2017.
MF portfolio overlap analysis tools.
Hi sir I have a long term investment view on wealth creation. I have 4 ELSS Mutual funds via SIP. My age is 25. Please suggest me whether I am investing in right direction or not.
Investment time – 10 yrs, goal – Purchasing a house.
1. Axis Long Term Equity Fund – – Direct(Growth), 1500
2. Reliance Tax Saving Scheme – – Direct(Growth), 1000
3. SBI Magnum Tax Saving Scheme – – Direct(Growth), 1000
4. Franklin India Tax Shield – – Direct(Growth), 1000
Apart from this I have a PPF account with annual investment of around 30000. I have sufficient life insurance so now my only focus is to get better investment returns.
Please suggest any other investment scheme.
Thanks
Dear Anshu,
I believe investing in too many funds that too from same fund category can be avoided.
Kindly check portfolio overlap among these funds and try to limit to may be 2 funds.
Kindly note that units allotted under each SIP of ELSS fund have a lock-in period of 3 years, so you need to plan your withdrawals accordingly.
Read :Best Equity funds to invest in 2017-18.
Hi sreekanth,
good Article
i want to invest in mutual fund.but i am fresher.i have little quest?
demat is compulsory for investment in mf.
if yes, can i go from anglebroking
Dear alpesh ..It is not compulsory.
Hi sreekanth,
Really Good Article....Thanks for sharing information..i read this article today.
I am 30 year old, few months before i got SIP of 3000 Rs in ICICI value discovery Growth...this i have choosen for my retirement. Can u please tell me if i have done right?
Or which is the best fund for retirement at this moment...considering investment for 30 years from now.
regards,
Dear Abhee,
It is a typical multi-cap equity oriented fund with around 60% allocation to Large-cap stocks. I believe that any equity fund which have been performing consistently well can be part of ones long-term portfolio.
It is a good one.
In case, you are planning to add one more SIP for long-term (30 years), you may add one mid/small cap fund.
Read: Best Equity mutual funds.
Hi sree,
How to purchase mutual fund from different AMC using a single platform. I am thinking for using ICICI demat account in this case.Is this a good idea?
please guide.
Dear Abhee,
Personally i do use icici direct for some of my investments, but the transaction charges are on the higher side but with good service.
Kindly check out MF Utility platform for investing in Direct plans.
Read:
MF utility - How to invest in direct plans?
What are Direct plans of MF Schemes?
Ok. I will check.Thanks
Hi Sreekanth,
Thanks for your valuable information. It helped me decide on investing in SIP. I am very new to SIP and I want to invest in SIP plans for two purpose - short term (emergency) which I can withdraw on emergency case so a plan which will give me more returns in short term cases say 1 yr or 2 yrs. And plans for long term say 10 yrs-15yrs for (home,children,education,marriage and retirement). I am 33 yrs old. I would like to invest total 10k for above 2 purpose. One of the plan i would prefer from SBI and ICICI. Please suggest me better plans. Thanks...
Dear Shilpa,
For accumulating emergency fund - you may consider a Liquid fund + an Arbitrage fund.
Kindly read:
Best Debt funds.
Best Arbitrage funds.Long term goals:
Kindly go through below articles -
Retirement goal planning & calculator.
Kid's education goal planning.
You can consider investing equity oriented plans for long-term goals.
Read: Best Equity funds.
Shreekanthji, very happy diwali to you and your family. I want to check my mutual fund portfolio. My SIPs are as follows :
Axis long term (elss) : Rs. 2000 (horizon 7 yrs.)
Reliance growth : 1000 (with insurance) horizon 10 yrs.
Reliance equity opportunities : 2000 (1000 with insurance) horizon 7 yrs.
Hdfc balance : 2000 (horizon 5 yrs.)
Icici pru value discovery : 2000 (horizon 5 yrs.)
Franklin smaller companies : 2000 (horizon 10 yrs.)
PPF : 10000
Is it ok? My age is 50 yrs.
Dear Pratap,
I believe that there are better funds available in mid-cap space than Reliance growth fund & Equity opp fund.
Read:
Best Equity funds.
MF portfolio overlap analysis tools.
Happy Diwali!
Dear Sreekanth,
I would like to do some bulk Mutual fund investment from my NRI account.
Is there any fund that we can consider instead of Bank Savings Account? My intention is to park the money for short term basis and switch to equity funds later. (in my knowledge, NRI investments should keep for 1year to avoid TDS.. is there any exceptional funds?).
Dear Jayan,
If you have to park for short-term basis, you may consider Liquid fund and then can do STP (Systematic Transfer) to Equity oriented funds (as per your requirements).
Kindly note that STPs are considered as normal redemptions. So, taxes are applicable on these transactions (on liquid debt fund).
Kindly go through these links :
Mutual Fund Transactions & Tax implications.
Best Debt funds.
Best Equity funds.
How to select right mutual fund scheme.
NRIs & FATCA Compliance requirement.
Dear Sreekanth,
I am 28 years old recently married, working in Central Govt. with 70k salary per month.
Following are my savings.
1) PPF- 35000/- p.a. started in 2015.
2) ICICI Pru I-Protect term policy- 30 Lakhs coverage - 4478/- p.a. for 33 years (Started in 2016)
Now am planning to invest in Mutual funds for my long time goals (above 8 years).
After so much study i have decided following portfolio for my investments
1) SBI Blue chip fund - 4k
2) Birla Sunlife Front line equity fund - 4k
3) ICICI Pru Value Discovery Fund - 4k
4) Franklin India Smaller company fund - 4k
5) Mirae Asset Emerging Blue chip/UTI mid cap fund - 4k
6) Franklin Tax shield- Every year 30000/- (may vary) as lumpsum for tax saving.
Please give your opinion on my portfolio and their performance in long run.
I am also thinking about fund size of funds sl.no: 2, 3. Is it ok if i have large size funds in my portfolio ?
Thanks.
Gopal
Dear Gopal,
All are good ones.
1 & 2 are large-cap oriented ones. So, kindly check overlap between 1 & 2 and 3 & 6 funds.
Read: MF portfolio overlap analysis tools.
Kindly consider buying a Personal Accident insurance plan (if you do not have).
Read:
Why is PA cover a must?
List of articles on Personal Financial Planning!
Thank You Mr. Sreekanth for your reply.
1) I have calculated portfolio overlap for funds: 1,2,3 and 6 and i found all combinations having overlap ratio below 35% except one combination. Overlap for funds 2 and 6 is around 50%.
Is this portfolio alright ? or do i need to change anything ? Kindly suggest.
2) As you suggested i will go through Personal accident insurance plans and i will buy suitable plan for me.
3) My parents(Farmers: Father-52 yrs & mother: 47 yrs) are dependent on me. They are covered with Central Govt Health Scheme (CGHS) as my dependents. Is CGHS coverage sufficient for my parents ? or do i need to buy any other health insurance plans for them ? If Yes,
Please tell me which Helath insurance plans will be good for people staying in small villages ? Because they are staying at my hometown(village near by Warangal) and I am working in Bangalore.
(Sometimes they are facing difficulties because, for any treatment they have to travel to Hyderabad or Bangalore for CGHS facility due to non availability of CGHS facilities near my hometown).
Thank You and waiting for your kind suggestions.
Regards
Gopal
Dear Gopal,
1 - You may drop one fund where the overlap is >50%.
3 - Sufficient or not, you are the best person to judge/know. Lack of medical facilities is the problem and we can do anything about it. So, you may consider taking stand-alone health insurance mediclaim policies for them. Do they have any health challenges?
Read:
Best portals to compare health insurance plans.
Evaluate these factors when buying health plan.
Dear Sreekanth,
1) If i want to drop fund no:2 then which large cap fund would to better to replace fund no:2 ?
3) As of now, my parents not having any health issues. Recently they have gone for full body check up and they were perfectly alright in all reports.
Thank you Mr. Sreekanth for enlightening people like us for better financial planning. After reading all your articles I am in a position to plan my financial goals. Really your doing wonderful job. All your articles having great stuff. I am suggesting this website to all my friends and colleagues. Finally thanks to my friend for suggesting this website to me.
Dear Gopal,
1 - Did you check their risk ratios :) ?
2 - So, its a good time to buy health insurance for them. May be you can consider - Super top up health insurance plans.
Thank you so much for your kind and motivating words.
By the by, may I know your friend's name??
Hello Sreekanth,
1) While shortlisting my portfolio I have considered risk factors (Standard Deviation, Beta, Alpha, Sharpe Ratio) and i found they are OK for all funds in my portfolio.
Now i am planning to replace "Birla SL FL equity fund" with Birla Sunlife Top 100 fund". Is it a good fund to replace ?
2) I will consider your suggestion for buying Health insurance for my parents.
My friend who has told about your website is Madhanagopalan.
Dear Gopal,
1 - Birla Top 100 is a decent fund. But you already have SBI bluechip which is again a Large cap fund. So, kindly check the overlap and take decision.
Thank You Mr. Sreekanth.
Hello Sir ,
Thank you very much for all your advice and guidance to all investor.
I m a NRI .. and Invested in below mentioned SIP ( Rs. 5000 each ) started 2 months back ) for long term retirement goal .
Franklin India Smaller Companies Fund GROWTH
Mirae Asset Emerging Bluechip Fund - Regular Plan Growth Option
PARAG PARIKH LONG TERM VALUE FUND - GROWTH
ICICI PRUDENTIAL VALUE DISCOVERY FUND - GROWTH
KOTAK SELECT FOCUS FUND -GROWTH OPTION
SBI BLUE CHIP FUND - REGULAR PLAN - GROWTH
Kindly advice above MF is ok or can i change the fund .
Thanks
Dear Nithin ,
All are decent funds. But you have 3 Multi-cap funds in your portfolio (ICICI/Kotak/Parag).
So, suggest you to check the portfolio overlap among these funds and if the overlap is on a higher side then you may trim down your portfolio.
Read:
MF portfolio overlap analysis tools.
How to select the right mutual fund scheme?
Hi,
I read your website from time to time. You are doing a nice job by providing valuable investment education to people. Please keep it up.
I would like to know your suggestion on my monthly MF portfolio allocation (Since the beginning of this FY)
1. Axis LT Equity (ELSS) 3000
2. BSL Tax Relief 96 (ELSS) 1000
3. Franklin India Tax Shield (ELSS) 1000
4. HDFC Balanced Fund 1000
5. Mirae Asset Emerging Blue Chip 2000
6. DSPBR Micro Cap 1500
Total 9.5K
I have a plan to limit my ELSS fund count to 2 after monitoring the performance for 2 years while keeping the total ELSS flow intact.
Additionally , can I add one more midcap to my portfolio or continue with Mirae alone (it's giving me around 80% CAGR till date, although the investment period is so small for this to be of any significance).
Also, would like to know your view on BSL Pure Value fund. It interested me for the value (actually blend) oriented investment approach , which is quite rare in midcap space.
Thanks,
Sayak
Dear Sayak,
Yes, you may trim down your portfolio a little bit.
Read:
Best Equity Tax saving funds.
How to compare and select the right mutual fund scheme based on Risk Ratios?
You may continue with Mirae fund.