Mutual Fund Metrics

Explanation

 

Alpha

 

Alpha is the excess returns of the fund over the benchmark. It helps in measuring risk-adjusted performance of a portfolio thus, giving performance ratio of that fund. It represents the market’s movement as a whole. Alpha depends on two factors: the assumption that market risk, as measured by beta, is the only risk measure necessary and the strength of the linear relationship between the fund and the index, as it has been measured by R-squared. A positive alpha figure indicates the fund has performed better than its beta would predict. In contrast, a negative alpha indicates the fund’s underperformance, given the expectations established by the fund’s beta. In fact, negative alpha can sometimes result from the expenses that are present in a fund’s returns, but not in the returns of the comparison index.

 

Beta

Beta is a statistical tool, which gives you an idea of how a fund will move in relation to the market. In other words, it is a statistical measure that shows how sensitive a fund is to market moves. By multiplying the beta value of a fund with the expected percentage movement of an index, the expected movement in the fund can be determined. A beta of 1.0 indicates that the investment’s price will move in lock-step with the market. A beta of less than 1.0 indicates that the investment will be less volatile than the market, and, correspondingly, a beta of more than 1.0 indicates that the investment’s price will be more volatile than the market.

 

R Squared

R-squared measures the relationship between a portfolio and its benchmark. It is not a measure of the performance of a portfolio. A great portfolio can have a very low R-squared. It is simply a measure of the correlation of the portfolio’s returns to the benchmark’s returns.

General Range for R-Squared:
• 70-100% = good correlation between the portfolio’s returns and the benchmark’s returns
• 40-70% = average correlation between the portfolio’s returns and the benchmark’s returns
• 1-40% = low correlation between the portfolio’s returns and the benchmark’s returns

 

Standard Deviation

It shows the dispersion about an average, that is how widely a mutual fund’s returns varied over a certain period of time. It gives the investors the range of returns that are most likely for a given fund. When a fund has a high standard deviation, the predicted range of performance is wide, implying greater volatility. In simple words, the more that data is spread apart, the higher the difference is from the norm. With mutual funds, the standard deviation tells us how much the return on a fund is deviating from the expected returns based on its historical performance.

 

Sharpe Ratio

It is calculated by using standard deviation and excess return to determine reward per unit of risk. The higher the Sharpe ratio, the better the fund’s historical risk-adjusted performance. The Sharpe ratio is calculated for the past 36-month period by dividing a fund’s annualized excess returns over the risk-free rate by its annualized standard deviation. It is calculated by subtracting the risk-free rate of return from the rate of return for an investment and dividing the result by the investment’s standard deviation of its return. The greater an investment’s Sharpe ratio, the better its risk-adjusted performance.

 

Treynor Ratio

Treynor Ratio is a measurement of efficiency utilizing the relationship between annualized risk-adjusted return and risk. It measures returns earned in excess of that which could have been earned on a riskless investment per each unit of market risk. In other words, the Treynor ratio is a risk-adjusted measure of return based on systematic risk. It is similar to the Sharpe ratio, with the difference being that the Treynor ratio uses beta as the measurement of volatility. Also known as the “reward-to-volatility ratio”.
The Treynor ratio is calculated as:
(Average Return of the Portfolio – Average Return of the Risk-Free Rate) / Beta of the Portfolio

 

Information Ratio

The information ratio (IR) measures a portfolio manager’s ability to generate excess returns relative to a benchmark, but also attempts to identify the consistency of the investor. This ratio will identify if a manager has beaten the benchmark by a lot in a few months or a little every month. The higher the IR the more consistent a manager is and consistency is an ideal trait.  For a given level of risk taken, a higher active return will result in a higher IR, which in turn proves the consistency of a manager in delivering superior returns.

 

Expense Ratio

The expense ratio is the annual fee that all funds or ETFs charge their shareholders. It includes, management fees, administrative fees, operating costs, and all other asset-based costs incurred by the fund. Portfolio transaction fees, or brokerage costs, as well as initial or deferred sales charges are not included in the expense ratio. The expense ratio, which is deducted from the fund’s average net assets, is accrued on a daily basis.

 

Portfolio P/B Ratio

Price to book ratio (P/B Ratio) is a ratio used to compare a stock’s market value to its book value. It is calculated by dividing the current closing price of the stock by the latest quarter’s book value per share. A low P/B ratio indicates that the stock is undervalued that is,something is fundamentally wrong with the company. This ratio also gives some idea of whether you’re paying too much for what would be left if the company went bankrupt immediately.

 

Portfolio P/E Ratio

The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing a company that measures its current share price relative to its per-share earnings. It gives the worth of company’s share. It is equal to a stock’s market capitalization divided by its after-tax earnings over a 12-month period. Companies with high P/E ratios are more likely to be considered “risky” investments than those with low P/E ratios, since a high P/E ratio signifies high expectations. The price-earnings ratio can be calculated as:

Credits: Divya Agarwal