Mutual Funds are all the rage these days. And why wouldn’t they be! They have the potential to offer reasonable returns in the long run. However, it is important to select the right fund for oneself. Read on to know the most important ratios that you should take into consideration to analyze the various options available and select the right mutual fund.
MAlpha denotes the excess return that a fund gives you when compared to a market benchmark or index. For example, if a mutual fund generates an annualized return of 12% as against a 10% given by the underlying benchmark, then the alpha is 2%. Hence, higher is the value of alpha, more profitable it becomes for the investors.
Beta measures the risk or volatility associated with a fund in comparison to the market or a benchmark. It shows the direction (up or down) as well as magnitude of movement in the fund’s value (also referred to as Net Asset Value or NAV) with a fluctuation in the market index such as Sensex or Nifty. Beta can be equal to, greater than or less than 1. A Beta of 1 means that the fund’s NAV is likely to replicate the movement in the benchmark or the market. If the Beta is less than 1 it means the NAV of the fund experiences milder price swings than the benchmark while if it is more than 1 it means the fund’s NAV swings more severely than the benchmark.
High Beta funds are more volatile than the benchmark. They tend to beat the benchmark when it goes up, but they also fall more than the benchmark when it comes down. This makes them relatively risky investments. You may pick high Beta funds if your objective is to maximize your gains and are also prepared to bear big losses. You may go for low Beta funds if you are satisfied with modest returns, but do not want much volatility.
Named after its creator Professor William Sharpe, this ratio enables one to judge the return from the fund in relation to the risk involved. In other words, the Sharpe Ratio assesses the returns generated by a portfolio against per unit of risk undertaken. This Ratio can be useful only if it used as a comparative tool. You can compare the Sharpe ratio of a fund with that of its benchmark index. A higher Sharpe Ratio will represent a higher return generated by a scheme per unit of risk taken.
This ratio is expressed in the form of a percentage and indicates the operational cost involved in managing the fund. The amount collected as Expense Ratio goes towards costs incurred as legal fees, administration and management costs, advertising related expenses etc. A fund with a higher expense ratio will ultimately lead to lesser returns for the investors. For instance, if you have invested one lakh in a fund and the expense ratio is 2%, then you would need to pay Rs. 2,000 (2% of Rs 1 Lakh) to the fund house.
It is important to remember that none of these ratios in isolation are sufficient to select the right fund. Investors need to use them in conjunction with each other to get the reasonable results. Also, it is equally important to analyze these numbers in relation to one’s own financial goals and risk appetite.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.