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,
I'm a beginner to this Mutual Funds type of investment. I would like to invest around 20,000 per month in SIPs for long term 7 to 10 years time frame. I'm planning to invest in the following schemes, please review my port folio and let me know if I should opt for different schemes or change the amount allotted to each scheme:
1. SBI Blue Chip - Growth - Direct - 2000
2. Frankline Templeton Prima Plus - Growth - Direct - 3000
3. ICICI focused bluechip equity - Growth - Direct - 5000
4. Birla SL Front line Equity Fund - Growth - Direct - 5000
5. Axis long term equity - 2000
6. ICICI Prudential Balanced Fund - 3000
Thanks,
Aruna
Dear Aruna,
You have three large-cap oriented funds (1, 3 & 4). It may not be beneficial to invest in funds which are from same fund category.
Kindly read: MF portfolio overlap analysis tools.
Other three funds are fine.
Read:
Best Equity funds.
Hi Sreekanth,
Thanks for taking the time to answer my query.
After your suggestion and reading further, I've removed "Axis long term equity" from my list as my 80C tax section is already full.
I've come up with following port folio:
1. SBI Blue Chip – Growth – Direct – 5000 Rs (Large cap - 10 yrs)
2. HDFC Balanced Fund - Growth - Direct - 5000 Rs(Hybrid - Equity Oriented - 3 to 5 yrs)
3. Franklin Templeton Prima Plus - Growth - Direct - 5000 Rs(Multi cap - 10 yrs)
The percentage of overlap accross SBI Blue Chip, ICICI focused bluechip equity and Birla SL Front line Equity Fund is very high (56% - 76%).
I've choosen SBI Blue Chip as it is low risk fund and has low overlap againt FT Prima plus compared to ICICI focused bluechip equity and Birla SL Front line Equity Fund.
But I'm little worried about the consistancy as during the 2008 fall of stock market, SBI Blue Chip performance was low compared to its peers(Birla and ICICI).
Later it seems to deliver good performance after the new manager appointed in 2010.
1. Do you think I can still bet on SBI Blue Chip fund for long term time frame? If not, could you please suggest any alternative fund?
2. Over all, I'm investing 15000 per month. I just equally distributed the amount across all the funds. Should I increase/decrease the amount invested in each of these
funds to achieve the better retuns? (for ex: 1. SBI - 7000 Rs 2.HDFC - 3000 Rs 3.FT - 5000 Rs)
3. If at all I wanted to invest in another SIP, which one do you suggest? (except the one listed above)
Thanks,
Aruna.
Dear Aruna,
1 - It is a decent fund with low risk profile.
2 - The time-horizon is different for balanced fund, so kindly check the allocation % as per your expected/required goal amount/corpus amount.
3 - One Mid-cap or Small cap for >10 year period. Ex- DSP micro cap or Franklin smaller cos fund.
Hi Sreekanth,
Thanks so much for all your patience and for all your help in answering my queries.
Aruna.
Hi Sreekanth,
Thank you for your time in writing down details about such kind of mutual funds. I completely believe that mutual funds when invested in long run generate lot of wealth.
vs real estate with facts and figures why real estate is a dull investment
I hope this would be useful for your readers
Thank you dear Vipul for sharing the article. All the best!
Sree, can you share your views on Mirae Asset Emerging Bluechip Fund - dirct plan
Comparing with peers it is showing good metrics
Download Data
Fund | Rating
Fund Risk Grade
Standard Deviation
Sharpe
Ratio
Sortino
Ratio
Beta
Alpha
R-Squared
Franklin India Prima Fund - Direct Plan | Below Avg. 17.06 1.53 2.43 0.99 18.44 0.79
HDFC Mid-Cap Opportunities Fund - Direct Plan | Below Avg. 17.18 1.50 2.61 0.95 18.44 0.72
Mirae Asset Emerging Bluechip Fund - Direct Plan | Low 16.46
Dear Harish ..On risk parameters, Mirae fund looks good.
One of the confusion I have faced when having multiple MF, especially Large Cap Funds is that of the portfolio overlap. If you have large number of Large cap funds, if they not selected carefully, may have portfolio overlap. Meaning, large of the individual stocks have the same configurations in various MFs. So diversification of sectors within the Large Cap may not happen leading to similar returns. I was trying hard to find out the best tool for the same and came across thefundoo.com It has a amazing way to depict the overlapping.
I was wondering, if other can also share some of the outlook and dilemma in resolving these portfolio overlaps.
Dear Manja,
In any two given equity funds, one may notice some percentage of overlap. But the key point is to avoid holding two funds with higher overlap say 75% overlap. As there is no point in holding two funds with same portfolios.
Kindly read:
MF portfolio overlap analysis tools.
Thanks Sreekanth. Realized that thefundoo.com is already there in your suggestion list.
This overlap comparison tools have added a new dimension to my Investment. Realized that 2 funds in my portfolio are more or less the same, stopping the SIP for one of them and quickly to research to find another suitable one. I will come back with my picks, do help in suggestion.
Dear Sreekanthji, I want to invest in Mutual Fund to accumulate savings and compound the value, say for 5 to 7 years. In this connection, which fund would be suitable for me. Apart from other funds, do suggest me suitable funds from SBI Mutual Fund. I can invest a maximum of Rs.5,000/- only per month. Thank you.
Dear Kamal,
You may consider HDFC Balanced fund + Franklin Prima plus + SBI Bluechip fund.
Hi Srikanth,
Which is the best option in MF investment - Growth plan or Dividend re-investment plan. I read dividend re-investment will give us more value than Growth on long run. Pl. guide me.
Thanks,
Harinath
Dear harinath,
The Dividend Re-investment option can be slightly more tax efficient than the growth option for short-term (less than 12 months in case of equity funds).
But this again depends on quantum and frequency of dividends declared by the scheme.
If you would like to keep it simple then you may go with the GROWTH option. If holding period is not more than 12 months, it might really not make much difference.
Hi Sreekanth! I am planning to invest for long term and I have high risk tolerance and want maximum return possible.
I have decided to go with small cap or mid cap funds. However, I can not decide which mutual fund to go for.
Can you please suggest me which mutual fund is best among - DSPBR micro cap , Franklin I smaller co. , Reliance small Cap.
I compared them I find out even though DSP Micro cap seems like it gave more returns but it was more volatile then Franklin I smaller co. Which could make it look like that DSP have higher return. However in comparing absolute returns Franklin seems better option.
Can you please suggest me what your thoughts are on these mutual funds and also please suggest me long term small cap mutual fund that I can have in my portfolio.
Thank you,
Vishal.
Dear vishal,
Franklin Smaller companies is good pick. Personally, I have invested in this fund.
Read: Best Equity funds.
Dear Sreekanth,
I have read your blog and others too. Your articles on mutual funds are really good for first time as well as advanced investors. I have already invested in SIP as follows:
Axis bank long term equity (ELSS): Rs 2000
Franklin Templeton prima plus: Rs 2000
HDFC balanced Fund: Rs 1000
Franklin Templeton smaller com fund: Rs 1000
I want to invest Rs 2000 more in SIP. Should I go for large cap or diversified fund, or mid cap or micro cap? Please suggest a good fund as well.
Regards
Dr Dipon Sharmah
Dear Dr Dipon,
May I know your investment objective and horizon??
MF portfolio looks fine.
Read: MF Portfolio overlap analysis tools.
My investment horizon is 10 years. And my basic objective is wealth creation with less risk. Please suggest a good fund in addition to those mentioned above.
Regards
Dr Dipon Sharmah
Dear Dipon..Suggest you to make additional investments in any of the existing funds itself. Axis LTE (if for tax saving) else Franklin Prima plus.
Nice article Srikanth. One observation is for normal investors it is difficult to understand these standard deviation, beta ratios. Hence I adopted few strategies when I filter mutual funds for investment. Highest returns in last 10 years, 5 years, 3 years and 1 year. Second is ranking from Crisil and value research online. 3rd is checking how other investors are invest (AUM> Rs 100 Crores). How such fund is peforming in various market cycles. These would help investors to pickup right fund suitable to them.
Dear Suresh..Thanks for sharing your views. But, besides return analysis, it would be better if one also evaluates the MFs on various risk parameters too. The information as mentioned in the article is readily available, so it is same as comparing the returns, here the investor has to just compare the risk ratios.
Hi,
How One Time Investment for any SIP based mutual fund possible as mentioned by Immanuel David?
Thank you,
shankha
Dear shankha,
You mean to say that is it possible to do lump sum investment in a SIP fund? Kindly rephrase your query?