Investors are usually smitten away by the high returns a mutual fund has managed to offer and generally turn a blind on the amount of risk it carries. That’s because mutual fund investments are subject to market risk, and they are not obligated to give investors any fixed returns. Mutual funds are nothing but an investment tool that invests in accordance with the scheme’s investment objective. The pool of funds collected from investors is spread across various assets, including equity, debt, government securities, corporate bonds, etc. Mutual fund investors receive mutual fund units in the form of shares. These units are allotted depending on the existing NAV or net asset value of the fund. NAV is nothing but the current market value of the mutual fund minus its liabilities.
But before investing in any type of mutual fund, it is advisable that you measure the investment risk that it carries. This investment risk can be measured using various methods. Here are some tools/ratios which can be used to assess the risk profile of a mutual fund.
This tool is used to measure a mutual fund scheme’s performance with respect to how it manages to adjust risk. Alpha is used to identify the risk adjusted performance of a particular mutual fund scheme. What alpha does is that it takes a mutual fund’s risk profile into consideration and the risk adjusted performance to the benchmark or index that mutual fund is tracking. The difference between the return on investment as compared to the return on the benchmark is termed as ‘alpha.’ A negative alpha denotes that the scheme has underperformed and vice versa.
Beta refers to the sensitivity that a fund has towards the market vagaries. Beta, which is always known as the beta coefficient, is calculated using regression analysis to understand the volatility of funds towards the market as a whole. It is basically the performance of your fund and how the portfolio responds to the ups and downs of the market. In this context, the market refers to the benchmark or the index that a particular mutual fund is following. The beta is usually denoted as one. If the mutual fund’s beta falls below 1 during the rise / fall of the market, it denotes that the fund has low volatility and vice versa.
Standard deviation is nothing but a statistical measurement that scatters data from its mean. The more the spread across diversified data, the higher the deviation. In mutual funds, the standard deviation is added to the fund’s annual rate of interest to measure its volatility. The standard deviation, for mutual funds, notifies investors with how much a fund’s expected returns is deviating from the expected returns based on the fund’s historical returns.
A lot of investors tend to lay emphasis primarily on investment returns with little importance given to investment risk. The above risk measuring tools that have been discussed may provide investors with some idea about the risk/rewards ratio that a mutual fund portfolio holds. An advantage that investors hold here is that these measurements can be calculated online as they are available on numerous financial websites.
Hence depending on the one’s risk appetite and investment objective, investors can consider investing in those mutual funds whose risk profile is tolerable for them. Remember that every mutual fund carries a different type of risk, and these risks can be calculated using the above tools / measurements. So make sure that you measure the risk profile of every mutual fund before investing your hard earned money in it. If necessary, consult a financial advisor who can help you with financial planning and help you achieve your investment goal.