18 Oct These Two Numbers can Help you Pick a Better Mutual Funds Scheme…
Alpha and Beta are two Statistical Tools which, if used wisely, can help you pick up the right Mutual Fund Scheme.
A Mutual Fund’s Performance and Risk may be ascertained by many Statistical Tools. Some of these tools measure the Risk-Reward involved – which helps investors ascertain whether they should accept a certain degree of risk for a a particular level of return while investing in a Mutual Fund Scheme in a given circumstance at any given point in time. Here is an overview of Alpha and Beta.
Salient Features of Alpha and Beta are:
Alpha and Beta are used to measure Risk-Reward associated with Mutual Fund Schemes. Investors use them as tools to calculate and compare returns and risk and to select the Mutual Fund. Both Measurements use benchmark indexes and compare them against the individual security or a Mutual Fund to highlight a particularly tendency of Risk-Reward.
In order to enhance Returns from to total Portfolio, a desired level of risk has to be maintained consistently; and hence one needs to individually select risk to Alpha and Beta.
What does Alpha mean?
Alpha is considered as Measurement of a particular Portfolio/Mutual Fund Manager’s aptitude. Let us look at an example to understand as to what the Alpha connotes.
When investments made by a Portfolio/Mutual Fund Manager provides a Return of 10% for a Growth Mutual Fund against an overall Return of 6% in the Equity Markets, then it is considered to be far more impressive than in a situation where overall Equity Markets are earning 14%. In the first case, the Fund Manager would have a relatively high Alpha, while it would be just the opposite in the case of the second.
What does Alpha Represent?
Alpha is actually the representation in the difference between a Mutual Fund’s Actual Return versus Expected Return. It is a measure to gauge the level of Out-Performance, or in simple terms, how well or badly the Mutual Fund has performed, when compared to a Benchmark. A Positive Alpha would imply that a Mutual Fund has performed beyond its Yardstick or Benchmark Index. As in the example above, while an Alpha of -4 would indicate than the Mutual Fund has produced 4% lower Returns than its Market Benchmark. A Portfolio/Mutual Fund Manager always seeks a Positive Alpha.
What does Beta mean?
Beta is also referred to as the Beta Coefficient. It is tool to measure the Volatility of a specific Security or Mutual Fund by comparing it to the performance of a related Benchmark over a period of time. Beta measures the Relative Risk of a Mutual Fund or Portfolio. It reflects the Systematic Risk associate with a Mutual Fund. The Market Index has a Beta of One. Where there is a Beta higher than One, it means that the Mutual Fund is more volatile than the Benchmark. A Beta of 1.1 signifies that a Mutual Fund has a Volatility of 1.1 times the Benchmark’s Volatility.
Volatility per se is not bad. Beta suggests that if the individual Stocks in an Equity Mutual Fund are chosen in such a way that the Cumulative Beta stands at 1.2, then,when the Market Benchmark escalates by 10%, the Equity Mutual Fund is expected to move up by 12%; and the converse is also true.
What kind of Returns can Beta give?
In a Bullish Market, a Mutual Fund with a higher Beta will yield better Returns for the Investor, as higher Returns for taking higher Risks is expected. While in a Bearish Market, a Mutual Fund with a lower Beta would be more appropriate as it is defensive against the Market.
One must however be careful when choosing the right Benchmark to compute Alpha and Beta. For example, to calculate the Alpha of a Mid-Cap Mutual Fund, one must use Mid-Cap Index, and not a Large-Cap Index such as Nifty or SENSEX. The Alpha and Beta of each Scheme is easily available online.
Alpha Versus Beta
If an Investor was looking to take advantage of a Bullish momentum that he expects in the Market, it would be wise to check the Beta of various Short-Listed Equity Mutual Funds. This would help him choose the right vehicle to participate in the expected Market Action. IF the Investor feels the Market to be in a Bear grip, and that there are many under-priced Shares, and there was considerable scope for re-rating, then it is likely for him to look at actively managed Mutual Funds that can locate these “mispriced” opportunities. This will help to make money in excess of what the Market makes – over time. Here, it is the “Alpha” that the investor seeks to achieve – a Return in excess of Market Returns – which is primarily attributable to his superior stock-picking skills.
If an Investor desires Alpha Returns, then, by evaluating the past performance of his Mutual Fund Manager and the Alpha that he has delivered over incremental expenses over a long period of time, the Investor can achieve this objective. Though, this track record might provide a hint to the upcoming performance, it is no guarantee for higher Returns. If the primary concern for the Investor is the near-term momentum (upward or downward), Beta is a better measure to focus upon. If long-term Outer-Performance and wealth creation are the primary concerns, then the ability and the track record of the Mutual Fund Manager in delivering Alpha is what you should look into minutely.
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