Mutual funds are one of the most subscribed investment options among millennials. Mutual funds are not everyone's favorite as it's a new investment option among the traditional investors of FD, and Stocks. However, in the last few years the mutual funds' investment, particularly SIP has seen a surge. However, there is some risk involved in the mutual fund investment.
The confusion arises when the investor doesn't have proper knowledge about the risks around the mutual fund and how to calculate the risks.
Mutual Fund Risks
Mutual fund schemes are not products with an assured return as it is investment option that is linked with market ups and downs. Investing in Mutual Fund Units implies investment risks such as trading volumes, default risk, settlement risk, liquidity risk, and capital loss risk, among others.
As being said, the investment in mutual fund is subject to market condition, the value of investment increases or decreases when the price, value, or interest rates of the securities change in which the Scheme invests vary.
The NAV (Net Assets Value) of the Scheme may fluctuate in response to movements in the broader equity and bond markets, as well as factors affecting capital and money markets in general. Any Mutual Fund Scheme's success in the past does not guarantee future results.
Furthermore, it's important to note that mutual funds come in various forms, and types, but, basically they are of two types equity or debt, or in some cases hybrid. Each type of mutual fund possesses a different risk. Hence, having an understanding of the mutual fund risk ratio could help you to judge your investments.
Mutual Fund Risk Ratio
These are the mutual fund risk ratio that should be taken into consideration before making investment decision:
Standard Deviation Value
The standard deviation is used to see how much the returns differ from the average. It also offers an indication of how unpredictable fund returns have historically been. A lower number means that the performance will be more predictable. The larger the deviation from the average, the more dispersed the data is. The standard deviation of a mutual fund's return shows us how much it deviates from the predicted returns based on its past performance.
The beta of a mutual fund is a measurement of the fund's ups and downs in response to market movement. The beta ratio depicts the change in the fund's NAV in response to a change in the general market. Low beta is desirable since it indicates that the NAVs will not fluctuate much with market highs and lows. The tendency of an investment's return to respond to market changes is represented by beta, which is computed using regression analysis. A beta of one indicates that the returns will be skewed towards the benchmark returns.
Treynor Ratio ratio is close to or similar to the Sharpe Ratio in that it evaluates an instrument's excess returns above a risk-free rate. In contrast to the Sharpe Ratio, which utilizes total risk (SD), the Treynor Ratio employs market risk (beta) as the denominator. This ratio is also known as the reward-to-volatility ratio since it is calculated using the beta, which is a gauge of a security's sensitivity to market movements that are represented by a benchmark, such as the Sensex or Nifty for equities. The greater the Treynor Ratio, as with the Sharpe Ratio, the better.
The Sharpe ratio is a risk-adjusted performance indicator. The ratio shows how much risk was taken in order to earn the profits. The ratio is calculated by dividing a scheme's excess returns (above a risk-free rate) by the standard deviation of the scheme's returns for a particular time. The Sharpe ratio determines whether an investment's gains are the consequence of sound investing decisions or excessive risk. The higher the Sharpe ratio of an investment, the better its risk-adjusted return. While a portfolio of securities may yield better returns than its peers, it is only a sound investment if those higher returns do not come at the expense of too much more risk.
The Alpha Ratio shows how a fund outperformed a benchmark in terms of returns. The return and risk of the benchmark index are calculated using this ratio. The higher the Alpha, the better the fund's performance. The Alpha Ratio compares the risk-adjusted performance of a securities or fund portfolio to that of a benchmark index. Put simply, alpha refers to the value that a portfolio manager adds or subtracts from the return of a fund portfolio.