Alpha and Beta in Mutual Funds How It Is Calculated

Risk-adjusted returns are well captured by several rating agencies. It is simply a measure of the correlation of the portfolio’s returns to the benchmark’s returns. It tells you how much the fund’s return can deviate from the historical mean return of the scheme. If a fund has a 12% average rate of return and a standard deviation of 4%, its return will range from 8-16%. When calculating beta in Mutual Funds, there are two key components – covariance and variance. Covariance shows how two separate stocks react to each other in different market conditions.

• Check your Securities /MF/ Bonds in the consolidated account statement issued by NSDL/CDSL every month.
• The standard deviation has wide use in determining the risk of an investment.
• Any number in the negatives would suggest the asset manager’s performance as underwhelming.
• For example, if a mutual fund gives high returns you should try to understand if it is due to higher risk taken by the fund manager?

In the securities market, standard deviation measures the variance between the price and the mean of the prices. The higher the standard deviation, the higher is the variance between the stock prices and the mean of the prices. The standard deviation of a volatile stock is high in comparison to a blue-chip whose standard deviation is low.

How to interpret Standard Deviation with respect to investments?

It can be seen as the additional value the mutual fund manager adds or takes away from the return on your portfolio. While investing in a mutual fund, we often look at returns as a parameter for assessment. Along with returns, a fair assessment of risk can help you in making a prudent choice. One such way of assessing risks and volatility can be using a statistical tool called standard deviation. A critical ratio frequently used by fund managers, the standard deviation can greatly help investors. Let us understand the standard deviation meaning to help you assess risk better.

However, the standard deviation does not conclude on investment decisions, rather helps understand the data. Please note that this is a simplistic formula for beta for the purpose of your understanding. Beta is calculated in Excel using Regression tool in the Data tab. You may need to install data analysis pack in Excel unless it is already installed. It is used to measure the variation of a set of data from the mean or average. In the case of Mutual Funds, the standard deviation indicates the digression of Mutual Fund returns in different phases of the market from the average or mean as calculated prior.

Thumb Rule: Higher the Standard Deviation of Mutual Fund – Higher the Volatility.

You are advised to consult an investment advisor in case you would like to undertake financial planning and / or investment advice for meeting your investment requirements. In other words, if the standard deviation of a mutual fund is high, then the returns can be significantly higher or lower than the average. Thus, if the standard deviation of a scheme is 2% and its average annual return is 10%, then the future returns can range from 8%-12% (10%-2% and 10%+2%). Standard deviation can be defined as a statistical measurement of the volatility of a mutual fund scheme. It demonstrates the degree of variation from the simple average or arithmetic mean. Equity schemes have a higher standard deviation in comparison to debt schemes.

Beta measures the volatility of a security relative to something, usually a benchmark index. A beta greater than one means the fund or stock is more volatile than the benchmark index, while a beta of less than one means the security is less volatile than the index. Hence, MF schemes with high risk-adjusted returns are most sought-after.

Here’s Everything Investors Should Know About Standard Deviation in Mutual Funds

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But in finance, standard deviation refers to a statistical measure or tool that represents the volatility or risk in a market instrument such as stocks, mutual funds etc. A tool of statistics, standard deviation is used to measure variation from an arithmetic mean. In finance, standard deviation refers to a statistical measure representing the volatility or risk in a market instrument such as stocks, mutual funds etc. In an ideal world, investments would move in a smooth path in an upward direction, perfectly in line with the market conditions. But this is not the case in reality – the fluctuations might be rather stark and erratic. Though often less volatile than stocks, mutual funds are no exception to volatile, erratic behaviour.

The value 0 suggests that there is no percentage of funds in a portfolio reacts to movement in its respective benchmark index; whereas the value 1 represents that change in the benchmark index mirrors the movements in fund returns. You must compare a fund’s standard deviation to other schemes in the same category to determine whether it is high or low. Debt mutual funds are one example of a low-risk strategy with a low standard deviation.

Every investor has his/her own risk profile, and it is essential to have a clear idea about their personal risk profile as we all know that risk is measurable, and investors should make use of risk statistics while analysing and selecting mutual funds. Beta is based on the capital assets pricing model which states that there are two kinds of risk in investing in equities- systematic risk and non-systematic risk. Systematic risk is integral to investing in the market and cannot be avoided. Non-systematic risk is unique to a company – can be mimimised by diversification across companies. Since non-systematic risk can be diversified, investors need to be compensated for systematic risk which is measured by Beta. Save taxes with ClearTax by investing in tax saving mutual funds online.

Investing by considering only historical returns in a mutual fund scheme is risky. Investors need to evaluate the risk involved in mutual fund schemes before investing. Standard deviation is a statistical measure but widely applied in the finance industry and engineering field, to name a few. In financial measurements, the standard deviation’s application is found in obtaining historical volatility in prices or price movements. The results help determine the returns on investment over a period of time.

Striking the Right Balance Between Risk & Return

In comparison, actively managed Mutual Funds may have a range of R-squared values. Funds having an R-Squared of 80 or below tend to not perform like a typical index. A positive alpha is the extra return would be awarded to you for taking a risk, instead of accepting the market return.

Sharpe ratio is the ratio of the excess returns of the scheme over risk free rate to the standard deviation of the scheme. Information on this Website sourced from experts or third party service providers, which may also include reference to any ABCL Affiliate. However, any such information shall not be construed to represent that they belong or represent or are endorsed by the views of the Facilities Provider or ABC Companies.

Though it provides insight into the volatility of a particular mutual fund, there are some limitations of using Standard deviation. If the portfolio has several funds, then standard deviation cannot provide any comparable results. In debt funds, Gilt funds and Income funds have higher volatility than Liquid funds. These are not Exchange traded products, and the Member is just acting as distributor.

In layman terms, risk is the deviation from expected or average returns. Standard deviation is a statistical metric which measures the dispersion of returns from the average returns. For example, standard deviation of returns on equity fund is likely to be higher than a debt fund.

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In other words, this means that 68% of the time, Fund C’s future returns may range between 7% and 13% (10% average plus or minus its standard deviation of 3). Similarly, 95% of the time, the future returns are likely to fall between 4% and 16% (10% average plus or minus twice the standard deviation, i.e., 6). “KYC is one time exercise while dealing in securities markets – once KYC is done through a SEBI registered intermediary (broker, DP, Mutual Fund etc.), you need not undergo the same process again when you approach another intermediary.” If an actively managed mutual fund has a high R-squared value, it is probably structured like an index and is performing like one. Investors can use this information to align the Mutual Fund portfolio according to their risk profile.

• The standard deviation for this fund would then be zero because the fund’s return in any given year does not differ from its four year mean of 3%.
• Let us take a look at some key tools or ratios that measure this risk.
• If you are subscribing to an IPO, there is no need to issue a cheque.
• In technical terms, it is a dispersion of returns from the average over a period of time.

It was quite interesting, he along with Sumaira Abdi of Money Control. The show was an hit as people realised that there was something called SD in investing. He used to ask the investor to grill the fund managers on these concepts. As you can see in the table below, the Standard Deviation of equity funds is higher as compared to debt funds.

So on a risk and return perspective, Stock A is less risky than Stock B. Stock A has the potential to earn 10% more than the expected return, but is equally likely to earn 10% less than the expected return. Usually denoted with the letter σ, Standard Deviation is defined as the square root of the variance. The review may become more pronounced in case of thematic or sectoral schemes as they are more prone to the changing economic environment. 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. Stock brokers can accept securities as margins from clients only by way of pledge in the depository system w.

Higher the Sharpe’s what is standard deviation in mutual fund, better the risk adjusted return of your mutual fund portfolio. Apart from alpha and beta, other ratios to quantify a fund’s performance include Sharpe Ratio. Sharpe Ratio calculates the excess return generated by a mutual fund scheme over the risk-free rate per volatility unit . You should always try to invest in schemes with good track record of superior risk adjusted returns to ensure that you get superior performance without taking more risks than what is required according to your risk appetite.