Investing in mutual funds is a popular choice for busy Indians looking to grow their wealth. However, choosing the right mutual fund can be boring, especially with lot of performance metrics available. In this article, we’ll explain four key metrics that can help you evaluate mutual fund performance: Net Asset Value (NAV), Alpha, Beta, and the Sharpe Ratio. By understanding these metrics, you can select your suitable mutual fund to multiply your wealth.
1. Net Asset Value (NAV)
NAV stands for Net Asset Value, which represents the per-unit value of a mutual fund. It is calculated as:
NAV = (Total Assets – Total Liabilities) / Number of Outstanding Units
Example:
Suppose a mutual fund has total assets worth ₹500 crore and total liabilities of ₹20 crore, with 50 crore outstanding units.
NAV = {500 – 20}/{50} = {480}{50} = ₹9.60
Conclusion:
NAV gives you an idea of the per-unit value of the fund. A rising NAV indicates that the value of the fund’s holdings is increasing, which is generally a good sign.
2. Alpha
Alpha measures a mutual fund’s performance relative to its benchmark index. It shows whether the fund is worth more than the market or not.
A benchmark index is a standard against which the performance of a mutual fund or investment portfolio can be measured. It serves as a point of reference to evaluate how well or poorly a fund is performing relative to a broad market or sector.
Common Benchmark Indices in India
Nifty 50: Comprises the 50 largest and most liquid stocks listed on the National Stock Exchange (NSE).
BSE Sensex: Comprises 30 well-established and financially sound companies listed on the Bombay Stock Exchange (BSE).
Nifty 100: Represents the top 100 companies based on market capitalization listed on the NSE.
Nifty Midcap 150: Represents the performance of mid-cap companies.
Nifty Smallcap 250: Represents the performance of small-cap companies.
Let’s use the HDFC Top 100 Fund and the Nifty 100 as an example to understand how a benchmark index works.
Fund Performance: Suppose the HDFC Top 100 Fund has delivered an annual return of 12%.
Benchmark Performance: During the same period, the Nifty 100 has delivered a return of 10%.
Analysis:
Alpha Calculation: Alpha measures the fund’s performance relative to its benchmark. If the HDFC Top 100 Fund has an alpha of 2%, it means the fund has outperformed the Nifty 100 by 2%, indicating good management.
Example:
Imagine Fund A has an alpha of 2%, while Fund B has an alpha of -1%. Fund A has outperformed its benchmark by 2%, while Fund B has underperformed by 1%.
Conclusion:
A positive alpha means the fund has performed better than its benchmark, indicating good management. A negative alpha suggests underperformance.
3. Beta
Beta measures the volatility of a mutual fund compared to the market. It indicates the fund’s sensitivity to market movements.
Interpretation:
Beta = 1: The fund’s price moves with the market.
Beta > 1: The fund is more volatile than the market.
Beta < 1: The fund is less volatile than the market.
Example:
If Fund A has a beta of 1.2, it means the fund is 20% more volatile than the market. If the market goes up by 10%, Fund A is expected to go up by 12%.
Conclusion:
Higher beta indicates higher risk and potential return, while lower beta suggests lower risk and potential return.
4. Sharpe Ratio
The Sharpe Ratio measures the risk-adjusted return of a mutual fund. It shows how much excess return you receive for the extra volatility endured by holding a riskier asset.
Calculation:
{Sharpe Ratio} = {Fund Return} – {Risk-Free Rate}}{Standard Deviation of Fund Return}
Example:
Fund A has a Sharpe Ratio of 1.5, while Fund B has a Sharpe Ratio of 0.8. Fund A has generated higher returns per unit of risk compared to Fund B.
Conclusion:
A higher Sharpe Ratio indicates better risk-adjusted performance. It’s a useful metric for comparing funds with similar investment objectives.
Putting It All Together
Let’s compare two hypothetical mutual funds, Fund A and Fund B, using these metrics:
Metric | Fund A | Fund B |
NAV | ₹9.60 | ₹12.50 |
Alpha | 3% | -1% |
Beta | 1.1 | 0.8 |
Sharpe Ratio | 1.2 | 0.9 |
Analysis:
NAV: Fund B has a higher NAV, indicating a higher per-unit value.
Alpha: Fund A has a positive alpha, suggesting it outperformed its benchmark, whereas Fund B underperformed.
Beta: Fund A is more volatile than the market, suitable for aggressive investors. Fund B is less volatile, appealing to conservative investors.
Sharpe Ratio: Fund A has a higher Sharpe Ratio, indicating better risk-adjusted returns.
Conclusion
Evaluating mutual funds using NAV, Alpha, Beta, and the Sharpe Ratio can provide a comprehensive view of their performance, risk, and return characteristics.
NAV helps understand the per-unit value.
Alpha indicates performance relative to the benchmark.
Beta assesses market-related risk.
Sharpe Ratio evaluates risk-adjusted returns.
By considering these metrics, you can choose a mutual fund that aligns with your investment goals and risk tolerance, making your investing path more profitable and, possibly, more rewarding..
