Risk is the regrettable probability of losing part or all of the initial investment from an investor’s viewpoint. And when considering various fund kinds with varying risk levels, this potential for loss becomes a key deciding element.
Standard Risk Factors In Mutual Funds
- The NAV of the Scheme may change in response to movements in the larger equity and bond markets in addition to the factors that affect the worth of individual investments in the Scheme. Additionally, the NAV of the Scheme may be impacted by factors that have an impact on capital and money markets in general, including but not limited to changes in interest rates, currency rates, taxation, or other developments, and increased volatility in the market for stocks and bonds.
- Any mutual fund scheme’s past success cannot be used to predict its future performance.
- Mutual Fund Schemes are not products with guaranteed returns.
- Investment risks such as trading volume, liquidity risk, settlement risk, default risk, and potential principal loss are present when purchasing mutual fund units.
- The value of an investment in a mutual fund may increase or decrease due to changes in the price, value, or interest rates of the securities the scheme invests in.
How to determine or measure the risk associated with mutual funds?
Fortunately, ratios that assess the risks and volatility of each mutual fund portfolio already exist. When looking at several mutual fund offer documents will not only help you choose one better fund, but it will also improve your awareness of risk and volatility. Let’s examine some crucial metrics or ratios for assessing this danger.
Sharpe’s Ratio
Sharpe’s ratio calculates a mutual fund’s risk-adjusted returns using standard deviation. It will inform you how much your mutual fund portfolio has outperformed the risk-free return. This helps you determine if your gains result from wise investment choices or taking on too much risk. Your mutual fund portfolio’s risk-adjusted return will be higher if Sharpe’s ratio is higher.
The value of mutual fund investment may increase or decrease due to changes in the price, value, or interest rate of the securities in which the plan invests.
Standard Deviation
A statistical technique called the standard deviation is used to quantify how far the data deviates from the mean or average. When used in mutual funds, it indicates how far your portfolio’s return varies from your anticipated return, given the fund’s prior performance.
For instance, if the portfolio XYZ has an average return of 15% and a standard deviation of 7%, it suggests that it has the propensity to deviate by 7% from that average and may provide returns between 8% and 22%. The relationship between standard deviation and portfolio volatility is straightforward. Additionally, it is utilised to compute Sharpe’s Ratio.
Beta
The mutual fund’s beta rating indicates how sensitive it is to changes in the market. It serves as a gauge for the market volatility of the portfolio of mutual funds. By examining a mutual fund’s beta, you can learn how responsively the return on your investment options will be to market ups and downs.
The benchmark index that the fund tracks is referred to as the market in this context. The market’s or benchmark’s beta is always assumed to be 1. Compared to the benchmark index, any beta value below 1 indicates lower volatility, and any above 1 shows higher volatility.
Alpha
The extra returns over the market benchmark for a specific level of scheme risk are known as Alpha. Simply put, it assesses how much better off a fund has done than the benchmark index. For instance, if the fund performance benchmarks against the NIFTY 50 index delivered 11% while the NIFTY 50 index delivered 10% over the past year, then the Alpha is +1%. Additionally, if the fund underperforms and only makes 8%, the Alpha would be -2%.
Conclusion
Investment decisions should be based on evidence, facts, and the level of risk you are willing to take to achieve your financial goals. You can determine the likelihood of generating money on an investment or incurring a loss by analysing the risk-return relationship.
