Categories: Mutual Funds

How to select the right and best Mutual Fund Scheme based on the Measures of Volatility?

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;

  1. Compare the returns generated between Fund A and Fund B.
  2. Analyze and evaluate the volatility of returns between Fund A & Fund B based on measures of Risk.
  3. You can also compare returns of Fund A with the returns of its Benchmark index / Fund Category.
  4. 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

Sreekanth Reddy

Sreekanth is the Man behind ReLakhs.com. He is an Independent Certified Financial Planner (CFP), engaged in blogging & property consultancy for the last 14 years through his firm ReLakhs Financial Services . He is not associated with any Financial product / service provider. The main aim of his blog is to "help investors take informed financial decisions." "Please note that the views given in this Blog/Comments Section/Forum are clarifications meant for reference and guidance of the readers to explore further on the topics/queries raised and take informed decisions. The information provided, therefore, should not be viewed as financial, legal, accounting, tax or investment advice."

View Comments

  • Hello sir,
    I have been investing 3k per month in DSP Black rock micro cap fund through SIP since last two year.
    My investment horizon is between 15 to 20 years.
    I have observed that this fund has performed well but some of my friend's suggested to me to invest in Frankllin Smaller Cap fund which is good fund compare to DSP in terms of Risk as well as Returns.
    I have also read your some articals where you also suggest for Franklin smaller cap fund.
    Now i am little bit confuse, should i stop my current(DSP) fund and start new SIP in Frankllin India smaller cap fund.
    Pls suggest and advice.

    • Dear Nayan,
      Kindly stay invested in DSP micro-cap (considering your time-frame). It's not possible to invest in all good funds.
      It's a decent fund.

  • More I read, more in love with your website. Thanks for educating commerce illiterate like me. Admire your hard work and hope you continue to help people like me.

    • Dear Vicky ..Thank you for your kind words. Kindly share the articles with your friends and do keep visiting!

  • Dear Mr.Reddy,
    I am an NRI , I want to start investing in Mutual Funds with Lumpsum amount, it will be mix of 50% Balance fund , 25 % Midcap or Small Cap & 25% Monthly Investment plan. But, as you know market is at peak now and for next 2 to 3 months its may be on peak and then fall back. Till then I dont want to invest in Equity based mutual funds. Meantime can you please recommend me suitable Short term liquid investment plan/ instrument for 6 months to 1 years other than Fixed deposits, in which I can park these funds and earn higher interest than FDs and at the same time should not have entry or exit loads or Tax liability. The amount I want to invest is more than 10 Lakhs.

    Thanks & Regards,

    • Completely agree with Sreekanth. There is never a better time to invest than now! Yes, technically you can invest in the Debt funds and choose a right time to invest in Equity when the market is Ripe, but given the current situation, there is no significant news in short that may affect the market (Brexit is over). And of you want longer, you may just miss the current bull market!

      However, take a step back, don't invest just because you have 10 Lakhs, create a goal based investment, then check how much %age are you looking month-over-month and then distribute your funds in respective funds to achieve that goal.

    • Dear Tushar,
      Its very tough to predict the MARKETS and not advisable to TIME the markets.
      If you are investing for long-term goals, you may JUST DO IT now :)

  • Hi Sreekanth,

    I am Sankar, 32, Married, 1 male child (3.5yrs), working in a private company with monthly income of 60K.
    My Investments are 7K in MF's for the last 1 yr,
    My liability : LIC - 2.5K p.m, Home laon EMI - 21K, House Rent - 6.5K.

    Mutual Funds invested in SIP mode are,
    1. Axis long Term equity fund - Tax planning (4500/-)
    2. SBI magnum midcap fund (2500/-)

    Now i want to redistribute the Axis fund (Need advice) i.e., 3k to some other MF + wish to add 3K in some other funds (non TP scheme) as home loan is covering my 80c.

    Kindly advice which fund to choose among the following....

    I have chosen based on the above article (taking account of Alpha, beta, sharpe ratio, SD, etc) and checking from Valueresearchonline.com:
    1. Mirae Asset Emerging blue chip fund - Direct
    2. DSP Black rock micro cap fund.
    3. Franklin India Smaller Companies Fund - Direct Plan

    Else,

    suggest me some good fund with good return over a period of 10-15 yrs. I am a high risk taker.

    I am planning in SIP mode only for long horizon.

    Need your valuable guidance.

    Thanks & Regards,
    Sankar.

  • Dear sir,
    my question is foolish. I invest in many Equity MF's through SIP (Reliance mf). i have 34 SIP's of 100 rupees through my HDFC salery account. Will i be charged for so many ECS/Billers (Netbanking or ATM).

    • Dear prabhash ..May I know the reason for investing in so many funds? What is your investment objective(s)? / Strategy ?

  • Dear Sreekanth

    My Son wants to invest about Rs 15000/- P.M for long term SIP to substantiate Retirement as he has no PF/Gartuity because of contract service. Pl suggest some MF scheme to invest for 15-20 yrs with little Capital protection or no protection.

  • Hi, I would like to invest via SIP, 10 k per month for next 10 years.I have goal child education and marriage.
    so, basically, money i need after 10 years(education) and atleast after 20 years(yuonger kid marriage).

    I have lumsub 8 lakhs but hegitating to invest right now,since market is already in high and it is above 10 yr average.

    i am planning - hdfc balance fund - 3 k
    franklin snallar cos - 2 k
    kotak select focus fund (?, need one diversify fund) - 2 or 3 k
    one ELSS (axis LTEG - 2.5 k or Birala sunlife 96 - 2.5 k)
    Do,I need to buy any debt oriented fund or not?
    is this right time for lumsum or SIP ?
    Lumsum works better if market low,SIP work better if market is volatile and u expect fund monthly..

    Please advise..

    • Dear Sonu,
      Kindly read - Kid's Education goal planning & calculator.
      May be in next 10 years,we may see new highs w.r.t market indices, who knows...So, let's not try to TIME the markets.
      As you have long-term goals, any time is good time.
      You may create STPs (systematic transfer plans) from debt funds to equity funds.
      Your MF portfolio selection is fine.

  • Hi,

    I want to save money as emergency fund. So, could you please tell me which mutual funds suits for emergency fund.
    I am thinking about mip fund

      • Thanks for your reply.

        i have some plan regarding emergency fund. i am sharing with you please find it below

        i have decided emergency in two category for me. one is when i require money right at that moment. So, in this case i am expecting i should withdraw money at that moment instantly like withdraw from ATM.
        This money i will use for situation like any sudden accident

        second type of emergency is like if i loose my job but, in this situation i am not expecting instant cash at that moment...i can wait for 1 day-1 week & the possibility of happening this emergency will be very rare.

        For both emergencies, i am planning to invest for long term & won't withdraw or touch that money for other purpose

        Before going to conclusion i want to tell my current investment.

        Current Investment:
        1. Axis Long Term Equity Fund growth Direct
        2. Tata Balanced Fund growth Direct

        Above two funds grabbing major portion of my investment.

        So, for the first type emergency i am thinking of liquid fund & for second type of emergency i was thinking about MIP but as per your suggestion can i go for
        arbitrage fund...?

        one more query, for second emergency can we think of Debit fund.

        • Dear Abhijit,
          First type - Liquid fund + Cash at home + Balance in Sweep-in account can be considered.
          Second type - MIP is ok.

          • Hi,

            For Scenario 1, i am considering Escort Liquid Fund / Birla Sunlife Cash / HDFC Liquid Fund
            For Scenario 2, am Scenario Birla Sunlife MIP II Wealth 25 Plan

            i have gone through your article on liquid fund & MIP fund but those are for last years
            could you please check & tell me are above good funds to invest.

            one more note i fall in 20% tax bracket then should i select growth option for liquid fund...?

          • Hi Srikanth,

            Regarding Birla Sun Life MIP II - Wealth 25 Plan, i have one observation on mutual fund online site that this fund have sip duration "Daily".

            There is no monthly/quarterly sip option available & minimum sip investment also 1000 Rs.

            Could you please confirm.

          • Dear Abhijit ..Minimum amount is Rs 1000 but monthly SIP is also accepted. Kindly check with your online platform provider.

          • Hi Srinath,

            I have account in Mutual Fund Online site. I have checked there only & when i tried to select frequency then i found only one option as "Daily"
            that's why i am asking. So, if you have account in Mutual Fund Online then please check & confirm

            For Liquid Funds also i am getting only one frequency option that is "Daily".

          • Dear Abhijit ..I am not sure which platform you are referring to? Suggest you to kindly contact the service provider.

  • Hi Sreekanth,

    Thanks for the Blog. I am new to the MF investment.I am just learning about MF from your blog.

    I am planning to invest Rs 10 lakhs for my two children future needs. The Time frame would be 10 yrs & 15 yrs.

    I am willing to take moderate risk.

    Please suggest me on this following

    1 ,Is it better to invest in SIP or lump some.
    2,How to split the amount Between Large , Mid & Small cap mutual funds
    3,please suggest me some good MF in all these categories.(i saw your Best MF to Invest suggest one for my req)

    One last question may be a dumb question for ex if a NAV of MF Rs 30 now and after 10 years due to some reason again the NAV is same Rs 30 that mean there is zero returns on that MF

    • Dear JK,
      1 - As you have long-term goals, both can be beneficial. You can create SIPs and then can also make additional lump sum investments as and when you have extra investible surplus.
      2 - You can allocate higher % say 40% to mid/small cap fund for long term goals, may be 30% in diversified equity fund and the remaining in a balanced fund. As you are investing for longer period, suggest you not to stick to MODERATE risk. In case if you cant afford to take high risk, you may allocate more to a balanced fund.
      Read:
      My MF portfolio picks.
      Best Equity funds.
      What are large/mid/small cap funds?
      4 - Yes. (if opted for Growth option).

      • Hi Sreekanth,

        Today I posted a comment on this particular thread but can't find that here anymore. I didn't even get subscription email as well. :(. Trying to rephrase it here :
        Basically my query was on 4th point on this thread-

        Assuming I invest for a goal with 10 years horizon, in a fund having current NAV as '30'. Now suppose after 3 years NAV becomes 45 and after 5 years it reaches 55. Now I don't want to redeem the units as the target not reached yet.

        It's advised to move your corpus into safer investment options 1-2 years before the target time. As initial target period was 10 years, the equity funds need to be redeemed in 8th, 9th year. What if the NAV lies between 25-35 during this period. This will be a major loss even after making systematic investment, huge gains mid way and with having long time horizon.

        Above example could be really childish and improbable scenario but just a random scenario to learn about growth vs dividend options.

        Just framed above example to understand whether growth option should be followed blindly for long term investments or some % allocation should be in dividend option too?

        Let me tell you myself and my wife are investing (combined) 50 K per month in equities. Our portfolios are mixed of large cap, mid cap, ELSS, diversified, balanced funds etc. some of these investments are through SIP's and rest others via STP route (no diff though from equity perspective). All these monthly investments are in growth plans only as we are looking for long term goals and not looking to redeem any of these funds before 8-10 years. Please advise your views on growth vs dividend option and should I reallocate some investment from growth to dividend?

        • Dear Tarun,
          It is not a silly question, but valid one.
          But that's how the investment plan works, we need to be keep on investing in good and consistent investment avenues and hope for the best.
          We can't take away the risk but can try to minimize the impact of loss (can diversify across other Asset classless too).
          For fear of risk, if one avoids equities or equity funds (or investments which can beat inflation+taxes) then not investing sufficiently in these options can be more riskier (risk of wealth erosion) than actually investing.
          Even if you would like to invest in Dividend option, may I know what would you like to do with the received dividends? (consumption or re-investment)??

          • Hi Sreekanth,

            Thanks for your response.

            Regarding your point 'We can’t take away the risk but can try to minimize the impact of loss (can diversify across other Asset classless too).'

            If by other Asset classes you mean other than equity, i.e. debt funds, liquid funds, arbitrage funds, FD's etc then yes majority of our lump-sum corpus has been invested in these asset classes only. Please let me know if you meant something else with this statement.

            regarding next point of 'fear of risk in equity', let me tell you that's not a concern at all. As mentioned earlier, we are investing 50k per month in equities and will invest more n more as and when market goes down. I still believe if I can forget this much amount for long time frame then nothing is better than equity.

            Only doubt in my mind is of % allocation between growth and dividend options within equity funds only.
            And as you asked - 'Even if you would like to invest in Dividend option, may I know what would you like to do with the received dividends? (consumption or re-investment)??'

            If I invest in dividend option, that would be dividend reinvest only. I am going to invest only that money in equity which can be forgotten for long long time. I am not looking to consume dividend amount for any expense or intermediary goals.

            But I am still not sure if I need to make changes in my current investment pattern where all the equity investment is going into growth options only. Do I need to change this pattern for some part of equity investment as in dividend reinvestment? If yes what percentage should go there? What's your take on growth vs dividend options for investment in equity funds? If it is ok to keep investing in growth option, I'm good with that too. Just looking for your advice as always. :)

          • Dear Tarun,
            Different asset classes include Real-estate Property too.
            If you have long-term investment horizon, you may kindly opt for Growth option.

          • Thanks for the response Sreekanth. And yes three years back I made investments in real estate as well for self use but unfortunately neither I got possession yet nor there is any appreciation in the market. :(

  • Dear Sreekanth,

    I am new to investing in MFs and have been following your blog for past few days. Thank you very much for guiding all the MF investors.

    I currently have Jeevan Saral - annual premium 120k rs - 5 years premiums paid, surrender value 450k- 35yrs maturity - Life insurance sum assured 25lacs and maturity sum assured 51lacs.
    We also took out Jeevan anand - annual premium 80k - 4 years premiums paid, surrender value 150k - 21yrs maturity- sum assured is 15lacs.

    I want to start investing in MFs looking to build wealth in long term. My age is 31yrs and looking to invest in SIPs for 15yrs. I currently have Life insurance for myself and my wife through an Insurance company other than LIC so do not need insurance. Our main purpose was investment and the LIC agent showed us some graph at the time of buying the policy which assured over 10% return but after reading your posts and through my own research I found this to be incorrect.
    Kindly please advise if I should continue to invest in the above LIC policies or should I surrender and invest it in MFs?
    The agent said I can withdraw the policy after 10 years, if I withdraw money after 10 years, how would they calculate return? will I get the loyaty addition for each year or just the LA declared at 10th year.
    Please advise if it is better to continue till 10 years or to surrender now?
    Thank you

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Sreekanth Reddy
Tags: How to select best mutual fund Scheme
July 11, 2023

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