Decoding Risk Metrics in Mutual Funds: Key Insights

In prior discussions, we evaluated various features of a mutual fund. This segment focuses on essential risk metrics including Beta, Alpha, Standard Deviation, and the Sharpe Ratio.

Beta is a vital indicator, measuring a fund's relative risk versus a benchmark. For example, a Beta of 0.95 in the Tata Multicap Fund implies slightly lower risk than the S&P BSE 500 TRI, since a Beta below 1 indicates less risk. Conversely, a Beta over 1 suggests more risk compared to the benchmark. Think of it like comparing the speed of a Ferrari to a BMW—Beta shows relative, not inherent, risk.

Alpha gauges returns exceeding a benchmark on a risk-adjusted basis. For instance, if a fund returns 10% against a 7% benchmark with a Beta of 0.75, it achieves an Alpha of 3.75%. Notably, higher Beta reduces Alpha, thus penalizing funds with greater volatility.

Standard Deviation (SD) reflects a fund’s inherent risk level. A higher SD signifies more volatility and risk. For example, the Axis Small-cap Fund with an SD of 23.95% is riskier than the Axis Long Term Equity Fund with an SD of 19.33%.

The Sharpe Ratio evaluates fund performance by incorporating risk, return, and the risk-free rate, indicating the returns per unit of risk. A higher Sharpe Ratio denotes better fund performance and is more relevant for equity funds rather than debt funds.

Future discussions will cover the Sortino’s Ratio, Capture Ratios, and emphasize the construction of Mutual Fund portfolios.

Key Points:

• Beta measures relative risk against a benchmark; higher Beta indicates increased risk.
• Alpha evaluates risk-adjusted excess returns against benchmarks; higher Beta reduces Alpha.
• Standard Deviation exposes a fund's risk; a higher SD suggests more volatility.
• The Sharpe Ratio denotes returns per unit of risk; higher values are favorable.

Glossary of Terms:

• RBI: Reserve Bank of India
• MSMEs: Micro, Small and Medium Enterprises
• NSE: National Stock Exchange
• BSE: Bombay Stock Exchange
• UX: User Experience
• NPAs: Non-Performing Assets
• NRI: Non-Resident Indian
• RTGS: Real Time Gross Settlement
• IMPS: Immediate Payment Service
• NEFT: National Electronic Funds Transfer
• EMIs: Equated Monthly Installments
• IVR: Interactive Voice Response
• HUF: Hindu Undivided Family
• NRIs: Non-Resident Indians
• PAN: Permanent Account Number
• TPA: Third-Party Administrator
• TDS: Tax Deducted at Source
• STT: Securities Transaction Tax
• CPC: Central Processing Centre
• BOI: Body of Individuals
• AOP: Association of Persons
• LLP: Limited Liability Partnership
• OCI: Overseas Citizens of India
• Income Tax Act: Income Tax Act
• NBFC: Non-Banking Financial Company
• IRDAI: Insurance Regulatory and Development Authority of India
• NBFCs: Non-Banking Financial Companies
• HLPP: Home Loan Protection Plan
• GST: Goods and Services Tax
• IMF: International Monetary Fund
• KWD: Kuwaiti Dinar
• INR: Indian Rupee
• SGD: SGD
• MAS: Monetary Authority of Singapore
• GBP: British Pound Sterling
• EMI: Equated Monthly Installments
• OD: Overdraft
• EBLR: external benchmark lending rate
• MCLR: marginal cost of funds-based lending rate
• FATCA: Foreign Account Tax Compliance Act
• OECD: Organisation for Economic Co-operation and Development
• HUFs: Hindu Undivided Families
• PPF: Public Provident Fund
• EPF: Employees’ Provident Fund
• UPI: Unified Payments Interface
• PMJJBY: Pradhan Mantri Jeevan Jyoti Bima Yojana
• PMSBY: Pradhan Mantri Suraksha Bima Yojana
• APY: Atal Pension Yojana
• SIP: Systematic Investment Plan
• RTGS: Real-Time Gross Settlement
• TDR: Ticket Deposit Receipt
• RAC: Reservation Against Cancellation
• CIBIL: Credit Information Bureau (India) Limited
• MICR Code: Magnetic Ink Character Recognition Code
• F&O;: Futures and Options
• KYC: Know Your Customer
• F&O: Futures and Options
• VAT: Value-Added Tax
• IFSC: Indian Financial System Code
• MICR: Magnetic Ink Character Recognition
• IRDA: Insurance Regulatory and Development Authority of India
• GRN: Goods Received Note
• PIN: Personal Identification Number
• OTP: One-Time Password
• SEBI: Securities and Exchange Board of India
• RTO: Regional Transport Office
• PUC: Pollution Under Control
• Indian Succession Act, 1925: Indian Succession Act, 1925
• HNIs: High-Net-Worth Individuals
• UIDAI: Unique Identification Authority of India
• NSC: National Savings Certificate
• Sukanya Samriddhi Yojana: Sukanya Samriddhi Yojana
• ATM: Automated Teller Machine
• MSMEs: Micro, Small and Medium Enterprises
• HSN: Harmonized System Nomenclature
• URN: Update Request Number
• SSUP: Self-Service Update Portal
• ETF: Exchange-Traded Funds
• Folio No.: Folio Number
• SFB: Small Finance Bank
• NGO: Non-Governmental Organization
• KEGF: Kerala Evangelical Graduates Fellowship
• MED: Micro Enterprises Development
• Muhurat Trading: Muhurat Trading
• PDF: Portable Document Format
• EPFO: Employees’ Provident Fund Organization
• EPS: Employee Pension Scheme
• LIC: Life Insurance Corporation
• NSDL: National Securities Depository Limited
• PFRDA: Pension Fund Regulatory and Development Authority
• NEAT: National Exchange for Automated Trading
• AuM: Assets Under Management
• REITs: Real Estate Investment Trusts
• ETFs: Exchange-Traded Funds
• UPI PIN: Unified Payments Interface Personal Identification Number
• Folio Number: Folio Number
• SWIFT: Society for Worldwide Interbank Financial Telecommunication
• AUM: Assets Under Management
• ESG: Environmental, Social, and Governance
• ATMs: Automated Teller Machine
• NRE: Non-Resident External Accounts
• GSM: Global System for Mobile Communications