Mutual Fund (MF), as an investment opportunity, is an important part of an investor's portfolio. In MFs, the money is managed by a professional fund manager, who is backed by a team of researchers.
There are many ways to analyze mutual funds before investing in them.
While understanding the risk tolerance, investment horizon and financial goals are essential before choosing mutual funds to invest in, there are certain financial ratios that can help investors in picking the best funds, based on their profile.
Here are the key ratios to consider before investing in mutual funds:
Standard deviation is a measure of how much the fund’s returns can deviate from its historical average. “This tells the investor about the volatility of the funds," explains Harsh Jain, Co-founder and COO at Groww.
A higher standard deviation means higher volatility and vice versa. Also, a higher standard deviation usually implies higher risk.
Alpha is the measure of the performance of a fund compared to its benchmark. According to Jain, a higher positive alpha means the fund has outperformed the benchmark by a said percentage.
This helps investors in understanding the sensitivity of the mutual fund to market movements.
“If beta is less than one, then the fund is less sensitive to change in the market, if it is greater than one, then it is highly sensitive to the said changes. Also, if beta is equal to one, then the fund moves in tandem to the market,” opines Jain.
Also read: How to open mutual funds online
This measures the relationship between a portfolio and its benchmark. A high r-squared value indicates that the fund performs more in sync with its benchmark.
This helps investors in analyzing if the returns offered by the mutual fund scheme are worth the risks taken by it.
"If a fund has generated good returns, this ratio can help investors in determining if the returns are due to smart investment choices or higher exposure to risk. A higher Sharpe ratio indicates higher risk-adjusted returns," Jain explains.
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First Published: IST