Mutual Fund Ratio

Investment in Mutual Fund is always subject to market risk and no one can predict the future. However, by study past performance ratios of the mutual fund will provide you understanding that how much you risk you will carry and help to compare with other similar fund. Lets understand few of such ratio which help investor to analyze their risk in the mutual fund.

01.   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. A higher standard deviation indicates greater volatility.

 

Example if Fund A SD is 20% and Fund B is 25% then Fund B is more volatile.

 

02.   Sharpe Ratio formula is SR =  (Fund return -  Risk free return)/ Standard Deviation.  By looking to the Sharpe ratio we can judge how much additional return generated in addition to the risk free return. Hence higher the sharpe ratio, better the fund from risk and return.  Lets understand how this ratio help to compare with its peer fund. 

 

	Fund A	Fund B
Return	22%	20%
Risk free rate	6%	6%
Standard deviation	18%	15%
Sharpe Ratio	0.89%	0.93%

 

Here Fund A generate more return by taking more risk and hence Sharpe ratio of B is better than A.

 

03.   Sortino Ratio is computed by dividing the difference between the aggregated earnings of an investment portfolio and the risk-free rate of return with the standard deviation of negative earnings.

 

Sortino ratio formula is given by – Sortino ratio = R – Rf /SD

R equals the expected returns Rf refers to the risk-free return rate SD equals the negative asset return’s standard deviation

The Sortino ratio uses only the downside volatility to evaluate a portfolio’s performance. On the other hand, the Sharpe ratio uses both the upside and downside volatility. Example of Sortino Ratio Calculation

Let’s take a look at this Sortino ratio example to understand how it is computed –Suppose, there are two investment portfolio schemes, namely – Scheme T and Scheme F with annualised returns.

 

Particulars	Scheme A	Scheme B
Annualised returns	10%	15%
Downward deviation	4%	12%
Rate of fixed deposit risk-free	6%	6%

From the above information,

Scheme A’s Sortino ratio = (R) – Rf /SD = (10-6)/4 = 1

Scheme B’s Sortino ratio =  (R) – Rf /SD = (15-6)/12 = 0.75

Typically, a higher Sortino ratio in mutual funds is considered to be better. So from the given outcome, Scheme A’s Sortino ratio indicates that it is generating more return per unit of the given risk and in turn has a greater chance of avoiding large losses.

04.   Treynor Ratio gauges how efficiently the fund manager achieves the balance between return and risk of the portfolio. The formula of ratio is

 

TR = (Fund return -  risk free return)/Beta of the fund.

 

Beta is a comparison with benchmark. Beta 1 means fund performance is equal to benchmark, more than 1 means fund is more volatile & riskier, and less than 1 means fund is less volatile.  

 

Let us understand TR with an example.    

	Fund A	Fund B
Return	18%	18%
Risk free rate	6%	6%
Beta	1.1	0.9
Treynor Ratio	0.11%	0.13%

 

It means that Fund A is more volatile than fund B.

 

05.   Jensen Alpha is  Portfolio return - [Risk Free Rate + Portfolio Beta * (Market Return - Risk Free Rate)]. This determines the abnormal return of a security or portfolio of securities over the theoretical expected return or in simple words compares the performance with benchmark return.   Let us understand by an example. 

 

	Large Cap A	Large Cap B	BSE 100 Index
Return	14%	11%	12%
Alpha	2%	-1%	NA

 

  Positive Alpha shows outperformer and -ve shows under performance.

 

Now lets compute Jensen Alpha for Large Cap A whose Beta is 1.1 and risk free return is 6%

 

=14- (6+1.1*(12-6)) =  1.4

The higher the Alpha value, the more rewarding the fund is.  

 

06.   Information ratio shows the consistency of the fund manager in generating superior risk adjusted performance. A higher information ratio shows that fund manager has outshined other fund managers and has delivered consistent returns over a specified period.  Formula for IR is

 

(Portfolio return – Benchmark return)/ Tracking Error. 

 

Tracking error is the deviation between fund return & index return.  Let us understand with an example.

 

	Large Cap A	Large Cap B
Fund Return	14%	14%
BSE 100 Index	12%	12%
Tracking Error	1.08	1.05
	=(14-12)/1.08	=(14-12)/1.05
Information ratio	1.85	1.90

 

Here Fund B is better than Fund A.

 

07.   Capture Ratio is the ratio of Up Market Capture Ratio and Down Market Capture Ratio. High Capture Ratio (more than 1) is good because it implies good risk adjusted returns. Negative Capture Ratio is also good, provided the negative is on account of Down Market Capture Ratio. The formula is

 

(i)              Upside Capture Ratio =  (Return in UP Rally / Benchmark Return)*100

(ii)            Downside Capture Ratio =   (Return in down correction / Benchmark Return)*100

Let us understand with example.

	Large Cap A	Large Cap B
Upside Capture
Fund Return	9.5%	13%
BSE 100 Index	10%	10%
Upside Capture Ratio	95	130
Downside Capture
Fund Return	-9%	-12%
BSE 100 Index	-10%	-10%
Downside Capture Ratio	90	120

 

The above table shows that Fund B gains 30 during upside and fund A loss only 10 during downtime.

 

Conclusion:  The captioned ratio will help investor to judge the risk & reward of the fund and help them to take calculated decisions. The captioned ratios are readily available at a number of investment website.