Hi, In this video, we will be talking about the ways through which we can measure and evaluate mutual fund performance.

Hi, In this video, we will be talking about the ways through which we can measure and evaluate mutual fund performance. The most popular way to measure the performance of a mutual fund is to use risk-return indicators. These ratios help us understand if the fund we are choosing can compensate us for the risk we are undertaking by investing in it. There are four widely-used indicators we will discuss in this video – Alpha, Beta, Standard Deviation and Sharpe ratio.

Let us start with Alpha. In simple terms, Alpha is the excess of the mutual fund’s risk-adjusted performance, over the performance of a chosen benchmark index like Nifty50 or SENSEX. If a fund has a positive alpha, it is said that the fund manager has “delivered an alpha” to their investors. On the other hand, a negative alpha can imply that the scheme is not even able to match the benchmark returns let alone excess returns.

Next, let us discuss the Beta. Instead of excess returns, the beta is used to compare the volatility of a mutual fund with the volatility of the market in general. The stock market is assumed to have a beta of 1. In comparison to this, if a fund has a beta higher than 1, it shows that the fund is more volatile than the market. On the other hand, a beta below 1 shows that the fund is less volatile than the market. For example, suppose a fund has a beta of 1.3, it is 30% more volatile than the market.

Now, let’s discuss Standard Deviation. As most of us would know, this measure is used to check the dispersion of all data from its average. For a fund, it is used to check the deviation of all returns from expected returns, based on historical data. Therefore, standard deviation is a popular way to measure the volatility of a fund. The higher this deviation is, the higher is the fund’s volatility and risk, and vice-versa.

Lastly, we have the Sharpe ratio. This ratio gives us the risk-adjusted performance of a mutual fund. It shows us how much additional return we are earning for every unit of risk we undertake by buying a unit of the mutual fund. It is a ratio of the risk-adjusted return to the volatility of the fund, which is shown by standard deviation. Suppose the risk-free return of treasury bills in India is 6%, and let’s assume that the return from a large-cap mutual fund is 10%.

Therefore, the excess return is (10-6), i.e.,4%. Now if the standard deviation is 2.5%, the Sharpe ratio will be (0.04)/(0.025) = 160% = (1.60). Sharpe ratio greater than 1.0 is considered acceptable to good by investors. A ratio higher than 2.0 is rated as very good. A ratio of 3.0 or higher is considered excellent. A ratio under 1.0 is considered sub-optimal. The higher the Sharpe ratio, the better performing an investment is, and vice-versa.

Thank you for watching the video.