Personal Finance

Performance indicators: The Alpha and Beta of Mutual funds

A mutual fund’s performance is assessed through the evaluation of alpha and beta.

A fund’s performance is measured against the benchmark companies’ performance considering alpha.  

The alpha value of a mutual fund can be negative, zero, or positive. Generally, the baseline for alpha in mutual funds is zero, which indicates the fund is giving the same returns as the benchmark. In case the alpha value is positive, the mutual fund has outperformed and if negative, it has underperformed the benchmarks.

For example, if funds are invested in the stocks of a company that has the Nifty 50 index as a benchmark, its performance is measured against it. 

If Nifty gets a return of 10% in a year, and the fund’s alpha is 5 in that year, it means the fund received 5% better returns than Nifty 50. This could also mean that the returns are 15% for the same year. Similarly, if the alpha of your fund is –5 for a particular year, the mutual funds have underperformed by 5% compared to Nifty 50 index. In this case, the returns would be 5% compared to the expected minimum of 10%.

Along with mutual fund performance, alpha can also indicate the efficiency of a fund manager in curating a profitable portfolio.

Mutual fund performance is directly proportional to volatility in the equity market. Beta, on the other hand, aids in measuring the returns a mutual fund can generate as the market conditions fluctuate compared to the benchmark. 

The baseline for beta in mutual funds is one. The beta value can be less than 1 or greater than 1. Funds with a greater beta are high-risk and more responsive to market fluctuations and vice versa. For example, if a mutual fund has a beta of 0.4, the mutual fund is 60% less volatile than its benchmark. While if the beta is 1.6, the fund is 60% more volatile compared to its benchmark.

Apart from these two metrics, there are other ratios to understand a mutual fund’s performance, which include standard deviation, R-squared, Sharpe ratio, and Sortino ratio, among others.

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