INVESTING IN MUTUAL FUND - RATIOS (PART-3)

Hello, dear readers,

I'm back with the latest installment of my ongoing series about mutual funds. In this part, we'll be delving into the key ratios commonly used to evaluate mutual fund performance. Understanding these ratios is crucial for making well-informed investment decisions.

This marks Part 3 of our series. If you haven't had the chance to read Part 1 and Part 2 yet, I recommend taking a moment to do so before continuing with this article. It will provide you with a solid foundation for understanding the topics we'll be covering here.

So, without further ado, let's begin our exploration of these fundamental ratios.

Expense Ratio : The expense ratio is like a fee that you pay toward covering the costs of managing and operating the fund.

• Let's say we invest ₹1,000 in a mutual fund, and it has an expense ratio of 1%. That means you pay ₹10 each year to the people who manage and run the fund.
• This expense ratio is important because it affects your investment returns. The higher the expense ratio, the more money you pay in fees, which can eat into the returns you earn from your investment.
• So, when you're choosing a fund to invest in, it's a good idea to look at the expense ratio. Lower expense ratios are generally better because they leave more of your money working for you, rather than covering expenses.
• But for example, passively managed index funds and ETFs tend to have lower expense ratios than actively managed funds because they aim to replicate the performance of a specific benchmark rather than relying on active investment strategies.
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Read: INVESTING Vs TRADING

Alpha (⍺): In simple terms, it is fund manager’s performance. It provides insight into whether the mutual fund has added value through active management of fund manager

alpha in the context of mutual funds represents the extra return that a mutual fund manager has generated (or failed to generate) compared to a benchmark index, considering the level of risk taken. It tells you whether the fund manager has done better or worse than a standard market benchmark. 

Positive alpha means outperformance and Negative alpha denotes under performance.

Beta (β): beta is a measure that helps you understand how a particular stock or investment tends to move in relation to the overall stock market. It provides insight into whether an investment is likely to be more or less volatile than the market as a whole

Beta of 1.0: If a mutual fund has a beta of 1.0, it means the fund tends to move in sync with the overall market. So, if the market goes up by 1%, the fund is expected to go up by a similar percentage, and if the market goes down by 1%, the fund is likely to go down by a similar amount.

Beta above 1.0: If a mutual fund has a beta greater than 1.0 (like 1.2), it tends to be more volatile than the market. This means it can potentially offer higher returns when the market is rising, but it can also experience larger losses when the market is falling.

Beta below 1.0: If a mutual fund has a beta less than 1.0 (like 0.8), it tends to be less volatile than the market. While it may not capture all the gains when the market is surging, it might also provide more stability and potentially smaller losses during market downturns.

Negative Beta: Some mutual funds may have a negative beta (e.g., -0.5). This suggests that the fund tends to move in the opposite direction of the market. When the market goes up, the fund might go down, and when the market goes down, the fund could go up. These funds are often considered defensive because they may help protect your investments during market declines.

Read: Know these to avail - Health Insurance

Sharp ratio: Certainly! The Sharpe Ratio in simple terms is a measure that helps you figure out if an investment, like a mutual fund, is giving you enough extra return for the amount of risk it carries.

Imagine you have two mutual funds with the same average return. One of them is riskier (more ups and downs), while the other is safer (more stable). The Sharpe Ratio helps you see which one is better.

Higher Number is Better: A higher Sharpe Ratio is better. It means you're getting more extra return for the risk you're taking.

Lower Number is Riskier: A lower Sharpe Ratio means you're not getting much extra return for the risk. You might be taking on more risk for the same return.

So, when you're comparing mutual funds, look at their Sharpe Ratios. It helps you see if you're being rewarded enough for the risk you're taking.

Sortino ratio: The Sortino Ratio in simple terms is a way to figure out if an investment, like a mutual fund, is doing a good job managing the risk of losing your money.

Higher Number is Better: A higher Sortino Ratio is better. It means you're getting more extra return for the risk of losing money (especially below a certain target return, like what you'd get from a safe investment).

Lower Number is Riskier: A lower Sortino Ratio means you might not be getting enough extra return for the risk of losing money.

So, when you're looking at different investments, you can use the Sortino Ratio to see which ones do a better job of managing the risk of losing your investment, especially when it comes to returns below a certain target.

Enough learning for today; we'll pick up where we left off in our next installment. Take some time to familiarize yourself with these terms and ratios and put them into practice. Please share your experiences here.

Alright, until the next part. See you soon!