Mutual Fund Ratios: A Guide To Maximizing Your Returns! - DivineBring

The number of mutual fund investors in India continues to grow as more individuals become aware of the benefits. People typically evaluate the past success of a mutual fund plan before investing their money in it.However, assessing the risks connected with a fund is just as important. Various ratios are used to measure the risks associated with a particular mutual fund plan. These “mutual fund ratios” can help investors better comprehend a fund’s performance.

A Comprehensive Look at Mutual Fund Ratios

The following are the details of several mutual fund ratios:

Alpha
This ratio measures a fund’s performance in comparison to its benchmark index. In other words, alpha indicates how effectively a fund manager has managed a fund. An actively managed fund’s alpha will be positive or negative, depending on the performance of the fund manager. Alpha’s baseline value is zero. If a fund’s alpha is larger than zero, it means that it is outperforming its underlying benchmark. If it is zero, the mutual fund performs identically to its benchmark index. A negative alpha indicates that a fund underperformed its benchmark.

Let me provide an example to illustrate this. For example, imagine the NIFTY 50 index earned 13% last year. If a mutual fund using the NIFTY 50 as its underlying benchmark delivered 10%, its alpha would be -3%. This means that the fund underperformed its benchmark by 3%.

The formula to calculate a mutual fund’s alpha is:

Alpha=(End Price + DPS – Start Price) / Start Price. Here, DPS stands for distribution per share.
Beta
This mutual fund ratio assesses a fund’s response to market changes. Simply explained, beta reflects the changes that a fund experiences in reaction to market movements as reflected by its benchmark index. Investors can evaluate a fund’s beta to determine its stability and sensitivity in a tumultuous market.

Beta is set at one in mutual funds. So, a beta larger than one indicates that a mutual fund is more volatile than its benchmark index. In other words, the fund is more responsive to market swings.If the beta value is less than one, it means that this mutual fund varies less in reaction to market swings than its benchmark index. When beta is equal to one, a mutual fund exhibits the same variance as its benchmark index.

For example, imagine a mutual fund has a beta of 1.5. This indicates that the fund is 50% more volatile than the benchmark index (say, Nifty 50). If the Nifty 50 rises by 5%, the fund’s beta will rise by 7.5% (1.5 times 5%).

The formula for calculating a fund’s beta value is (covariance / variance of market returns). Covariance demonstrates how two different stocks’ performance changes in response to changing market conditions.
Sharpe ratio
If an individual wants to earn larger returns, he or she may have to take on more risk. The Sharpe ratio is an important mutual fund risk ratio that investors can use to determine whether these risks are worth taking. This ratio might help you evaluate a fund’s ability to earn risk-adjusted returns. A portfolio’s risk-adjusted performance improves as the Sharpe ratio increases.

While the Sharpe ratio is an important metric for understanding fund performance, it should not be studied in isolation. To gain a better understanding, an investor can examine the Sharpe ratio as well as a fund’s standard deviation.
The formula for computing the Sharpe ratio is as follows:

Sharpe Ratio = Excess Returns (Average Returns – Risk-free Returns) divided by Standard Deviation of Fund Returns
Standard deviation
The standard deviation is a mutual fund risk ratio that represents a fund’s volatility or risk. It displays how far a fund’s current results depart from its historical average annual returns. A high standard deviation indicates significant volatility, or abrupt variations in a fund’s returns.When calculating a fund’s standard deviation, investors must keep in mind that its performance is governed by the law of averages. In other words, comparing a fund’s standard deviation to that of another allows for a better understanding and interpretation of the latter. This data can be used to compare two mutual funds of comparable types.
Let us provide an example to better understand how standard deviation works. Assume a mutual fund has a standard deviation of four and an expected return of fourteen percent. It implies that the fund’s returns vary by 4% on the high side (it may create 18% returns) and 4% on the low side (it can generate 10% returns).
Sortino ratio
The Sortino ratio is used to assess a fund’s performance in terms of downward deviation, particularly during difficult economic times. When investors assess a fund’s Sortino ratio, they gain a realistic view of its negative risks. This mutual fund ratio is used to evaluate an investment’s risk-adjusted returns.Sharpe ratios and Sortino ratios differ primarily in that the latter calculates risk using just downside standard deviations rather of the fund’s total volatility. As a result, a greater Sortino ratio indicates a high possibility for the fund to earn better returns while avoiding excessive risks.

The following is the formula for calculating a fund’s Sortino ratio:Sortino ratio = R – Rf / SD

Here, R = Expected returns

Rf = Risk-free rate of returns

SD = Standard Deviation of the asset which delivered losses
R-Squared
Investors can use the R-squared ratio to determine how similar a mutual fund is to its benchmark index. It is based on a scale of 1 to 100. A scheme’s higher R-squared value indicates a stronger connection with the benchmark index. For example, if the R-squared score is 100, it means that the scheme perfectly corresponds with the benchmark index.Index funds typically have a higher R-squared score. However, actively managed mutual funds may have varying R-squared values. For example, a scheme with an R-squared value of 80 or lower is not intended to perform similarly to the benchmark index.

However, if an actively managed fund has a high R-squared rating, it is possible that it was created to closely resemble the index. Generally, a fund with an R-squared value of up to 40% has low association with its benchmark. An R-squared number between 40% and 70% indicates moderate correlation, but an R-squared value more than 70% indicates strong connection. R-squared must be calculated in conjunction with other metrics such as correlation and standard deviation. The following is the formula for calculating the R-squared value:
R-squared = Square of correlation

Correlation = Covariance between benchmark index and portfolio / (SD of portfolio * SD of benchmark index)
Information ratio
This is a mutual fund ratio that shows how consistently a fund produces positive risk-adjusted returns. It assesses a fund manager’s ability to consistently create higher risk-adjusted returns and can be used to compare funds with similar management strategies. According to financial analysts, the information ratio is a more advanced version of the Sharpe ratio. It tells investors how much more return a fund has achieved in comparison to the excess risk absorbed based on its underlying benchmark.

To calculate the Sharpe ratio, divide excess returns by standard deviation. To find the information ratio, divide the active returns of a fund’s portfolio by the tracking error. The tracking error is the standard deviation determined from the difference between a fund’s and its underlying index’s returns. The formula is as follows:

IR (Information Ratio) = (Portfolio Rate of Returns – Benchmark Rate of Returns)/Tracking Error.
Treynor Ratio
The Treynor ratio calculates the excess returns that all securities or financial assets in a scheme generate for each unit of risk taken by the entire portfolio. In other words, it represents a fund’s risk-adjusted performance and can help potential investors shortlist mutual funds.In contrast to the Sharpe ratio, the Treynor ratio analyses an investment’s performance based on its systematic risks rather than its standard deviation. This mutual fund ratio helps investors determine if it is worth considering the risks associated with investing in a specific scheme and how much return they may expect.

Furthermore, it allows us to determine how well a fund manager can strike a balance between risk and return. To calculate the Treynor ratio, an investor must first determine a fund’s beta. The following are the details of its calculation:

Treynor Ratio = (Portfolio Returns – Risk Free Return Rate) / Beta of the Fund.
Expense ratio
Another crucial statistic to consider before investing in a mutual fund is the expense ratio. It is the fee that an investor must pay to the AMC (Asset Management Company) to manage his investments.It is a yearly fee imposed per unit for all expenses incurred by the AMC, including the fund manager’s salary, administrative charges, operational costs, marketing costs, and so on. A higher expense ratio indicates poorer returns. As an investor, you’ll want to choose a fund with a lower expense ratio.

People do not have to pay the expenditure ratio separately. It is determined as a percentage of the fund’s Net Asset Value (NAV) on a given day. The formula for calculating expense ratios is as follows:

Expense Ratio = (Total expenditures incurred by the mutual fund) / (Average Assets under Management)

Why Should You Consider Mutual Fund Ratios?

Analysing mutual fund ratios allows an investor to monitor the performance of a mutual fund. To obtain precise information on these indicators, go to a scheme’s fund fact sheet.

But first, let’s look at why it’s important to watch a mutual fund’s performance:

The performance of a fund is affected by market conditions, which means that changing market dynamics have an impact on mutual fund returns. As a result, investors must check the returns on their mutual fund investments to ensure that they meet their financial objectives.
A change in fund managers, mutual fund investment objectives, or asset allocation can all have a major influence on an investor’s portfolio. This impact may no longer be consistent with an investor’s financial aims. As a result, the investor may need to rebalance his or her investment portfolio and, in certain situations, reassess their decisions. It is recommended that you monitor the performance of your mutual fund on a frequent basis.
Investors should keep in mind that just because a fund has done well in the past does not ensure that it will do so again. To understand the fund’s overall performance, evaluate aspects such as the fund manager’s skill, performance against its benchmark, and asset allocation.

How Frequently Should You Evaluate a Mutual Fund’s Performance?

Important information on how frequently you should check the performance of your mutual fund is provided below: There is no set guideline for how frequently an investor should evaluate a fund’s performance. Although mutual fund investments are vulnerable to market risks, there is no need to evaluate a fund’s performance on a daily basis.
Another major aspect that influences frequency is an investor’s financial goal and portfolio makeup. For example, if a person has invested in an equity fund over a lengthy period of time, evaluating its performance every six months is a smart idea. As his investment term ends, he will be able to review it more frequently.
However, if an investor has made a short-term commitment, it is prudent to monitor fund performance more frequently. In that circumstances, it is critical to assess portfolio quality, market rates, and the fund’s short-term performance.

Many consumers avoid investing in mutual funds because they believe it is complicated. But this is not how it should be. Once you’ve determined your investing goal and time range depending on your risk profile, shortlist a few programmes. Then, compare the mutual fund ratios for each of these funds and select the one that best fits your financial goals.

FAQs

What are a fund’s annualised returns, and why is it important?

Annualised returns are the rate of return on an investment or portfolio of investments over a single year. It is computed by dividing the total return (including income and capital gains) by the initial investment or the investment’s average value during the specified time period.
Annualised returns are essential because they give a consistent method for comparing the performance of various assets over time. For example, an investment that returned 10% over six months would yield a 20% annualised return. This enables investors to quickly compare the success of various investments, regardless of the investing term. Annualised returns can also be used to assess the projected return on an investment over a longer time period, such as several years.

What is a fund fact sheet?

A mutual fund fact sheet is a document produced by the AMC that summarises a scheme’s performance. This document’s key components include annualised returns, related risks, investment objectives, and costs. It also displays several mutual fund ratios, allowing investors to keep track of their investments.