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Mutual Fund Ratios: What are Mutual Fund Ratios & Types of Mutual Fund Ratios

Investing in mutual funds has become increasingly popular among individuals looking to grow their wealth in India's dynamic financial landscape. The Assets Under Management (AUM) of the Indian mutual fund industry stood at around Rs. ₹ 46.37 lakh crore as on July 31, 2023. With an array of options available and the enticing prospect of returns, it's no wonder that many are drawn to the world of mutual fund investments. However, before diving headfirst into this field, it is essential to tread carefully and conduct thorough research, including ratio analysis.

MF Ratios also offer a window into a mutual fund's financial health, thereby allowing you to gauge its performance relative to its peers. Let’s dive deeper.

What are Mutual Fund Ratios?

Ratios in mutual funds are financial metrics that provide valuable insights into various aspects of a fund's performance, risk, and overall financial health. They are derived from analysing different financial data and are used by investors to assess the fund's performance and compare it with its peers before making informed investment decisions.

It is important to note that mutual fund ratios need not be considered in isolation. They are usually used in conjunction with other qualitative/quantitative factors, such as fund strategy, fund manager expertise, market conditions, and individual investor preferences.

Different Types of Mutual Fund Ratios

Expense ratio

This MF ratioreflects the percentage of a mutual fund's assets that are used to cover its operating expenses. It includes management fees, administrative costs, custodial fees, and distribution charges. A lower expense ratio indicates a more cost-effective fund, implying that a smaller portion of investors' assets is being used to cover expenses.

Here’s the formula to calculate the expense ratio:

Expense Ratio = Total Expenses / Average value of the portfolio

Standard deviation

Standard deviation is a risk ratio that measures the extent to which a mutual fund's returns deviate from its average return. It indicates the fund's volatility amidst different market conditions. A higher standard deviation suggests greater price fluctuations and the potential for larger losses. Conversely, a lower standard deviation indicates lower volatility.

Sharpe ratio

Sharpe ratio is one of the most important mutual fund ratios that assesses the risk-adjusted performance of the funds. It considers both the fund's returns and the level of risk taken to achieve those returns. Here’s the formula to calculate the Sharpe ratio:

Sharpe ratio = (Historic return of the fund - Risk-free return) / Standard deviation of the returns

A higher Sharpe ratio indicates better risk-adjusted performance, implying that the fund generated higher returns relative to the level of risk undertaken.

Treynor ratio

This is another risk-adjusted return ratio that evaluates the excess returns generated by a mutual fund relative to its systematic risk, as measured by beta. It indicates how efficiently the fund has utilised its systematic risk to generate returns. Here’s the formula to calculate the Treynor ratio:

Treynor ratio = (Portfolio risk - Risk-free rate) / Portfolio’s beta

Here, beta measures the fund's sensitivity to market movements. A beta higher than 1 indicates higher volatility compared to the market, while a beta lower than 1 suggests lower volatility.

Information ratio

The information ratio assesses a mutual fund's ability to generate excess returns above a benchmark, considering the level of risk involved. It measures the fund manager's skill in actively managing the portfolio and making investment decisions that can outperform the benchmark. A higher information ratio suggests better performance in generating excess returns.

Here’s the formula to calculate the Information ratio:

Information ratio = (Return from portfolio-Benchmark return) / Tracking Error

Alpha

Alpha is a mutual fund ratio that measures the performance of a fund relative to its benchmark. It provides insight into a fund manager's ability to generate excess returns beyond what would be expected based on market movements. If the alpha is positive, it means that the fund has outperformed its benchmark. On the other hand, a negative alpha can suggest underperformance.

Alpha = (Fund return – Risk-free rate) /[(Benchmark return – Risk-free rate)xBeta]

Beta

Beta is a mutual fund ratio that measures the sensitivity of the fund's returns to changes in the overall market. Here’s the formula to calculate the beta:

Beta = (Fund return – Risk-free rate) /(Benchmark return – Risk-free rate)

If a fund has a beta of less than 1 but consistently outperforms its benchmark, it may indicate that the fund has been able to generate higher returns while taking on less risk.

Sortino ratio

The Sortino ratio measures the risk-adjusted performance of an investment by focusing on downside risk. It gives investors a more nuanced view of a fund's volatility compared to traditional metrics like the Sharpe ratio.

Sortino Ratio= (Expected returns- Risk-free return)/ Standard Deviation (downside)

How Often Should You Analyse Mutual Fund Performance?

When it is about analysing mutual fund performance, it's important to strike a balance between being proactive and avoiding unnecessary obsession.

First off, you don't need to check the fund performance daily. Markets can be volatile, and short-term fluctuations are pretty normal. On the other hand, you need not be completely hands-off either.

For long-term investors with a "set it and forget it" approach, a yearly or semi-annual review would suffice. This allows you to track the fund's progress over a reasonable timeframe. However, if you're a more active investor, you might want to check in more frequently, like quarterly or monthly.

Additional Read: What is PEG Ratio?

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Disclaimer:
Helpful information for investors: All Mutual Fund investors have to go through a one-time KYC (know your Customer) process. Investors should deal only with registered mutual funds, to be verified on SEBI website under 'Intermediaries/ Market Infrastructure Institutions'. For redressal of your complaints, you may please visit www.scores.gov.in . For more info on KYC, change in various details & redressal of complaints, visit mf.nipponindiaim.com/investoreducation/what-to-know-when-investing This is an investor education and awareness initiative by Nippon India Mutual Fund.

The information herein is meant only for general reading purposes and the views being expressed only constitute opinions and therefore cannot be considered as guidelines, recommendations or as a professional guide for the readers. The document has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. The sponsor, the Investment Manager, the Trustee or any of their directors, employees, associates or representatives (“entities & their associates”) do not assume any responsibility for, or warrant the accuracy, completeness, adequacy and reliability of such information. Recipients of this information are advised to rely on their own analysis, interpretations & investigations. Readers are also advised to seek independent professional advice in order to arrive at an informed investment decision. Entities & their associates including persons involved in the preparation or issuance of this material shall not be liable in any way for any direct, indirect, special, incidental, consequential, punitive or exemplary damages, including on account of lost profits arising from the information contained in this material. Recipient alone shall be fully responsible for any decision taken on the basis of this document. Language Disclaimer:
While utmost care has been taken in translating the article into respective regional language(s), in case of any confusion or difference of opinion, article available in English language should be deemed as final. The article provided herein is meant only for general reading purposes and the views being expressed only constitute opinions and therefore cannot be considered as guidelines, recommendations or as a professional advice for the readers. The document has been prepared on the basis of publicly available data/ information, internally developed data and other sources believed to be reliable. The sponsor, the Investment Manager, the Trustee or any of their directors, employees, associates or representatives (“entities & their associates”) do not assume any responsibility for, or warrant the accuracy, completeness, adequacy and reliability of such information. Recipients of this information are advised to rely on their own analysis, interpretations & investigations. Readers are also advised to seek independent professional advice in order to arrive at an informed investment decision. Entities & their associates including persons involved in the preparation or issuance of this material shall not be liable in any way for any direct, indirect, special, incidental, consequential, punitive or exemplary damages, including on account of loss of profits arising from the information contained in this material. Recipient alone shall be fully responsible for any decision taken on the basis of this article. "ABOVE ILLUSTRATIONS ARE ONLY FOR UNDERSTANDING, IT IS NOT DIRECTLY OR INDIRECTLY RELATED TO THE PERFORMANCE OF ANY SCHEME OF NIMF. THE VIEWS EXPRESSED HEREIN CONSTITUTE ONLY THE OPINIONS AND DO NOT CONSTITUTE ANY GUIDELINES OR RECOMMENDATION ON ANY COURSE OF ACTION TO BE FOLLOWED BY THE READER. THIS INFORMATION IS MEANT FOR GENERAL READING PURPOSES ONLY AND IS NOT MEANT TO SERVE AS A PROFESSIONAL GUIDE FOR THE READERS."

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