.

Standard Deviation

If a mutual fund has a high standard deviation, this means that it is very volatile. If the standard
deviation is low, this means that you have a safer form of investment that will not experience extreme
highs and lows.

Mutual Funds Beta Definition and Example

Beta, with regard to mutual fund investing, is a measure of a particular fund's

movement (ups and downs) compared to the overall market. For reference, the
market is given a beta of 1.00. If a fund's beta, or what Morningstar calls "best-fit
beta," is 1.20, this tells an investor that they can expect the fund being measured
to have returns 20% higher than the index in an up market and 20% lower in a
down market.

For example, if a fund's "best-fit index" is the S&P 500 and the index has a return
of 10% this year, the investor would expect the fund with a beta of 1.20 to have a
return of 12%. Conversely, if the S&P 500 index fell 10% during the given year,
the fund with a beta of 1.20 would be expected to fall 12% during that year.

Alpha
Alpha measures the difference between a fund's actual returns and its expected
performance, given its level of risk (as measured by beta). A positive alpha figure indicates
the fund has performed better than its beta would predict. In contrast, a negative alpha
indicates a fund has underperformed, given the expectations established by the fund's beta.
Some investors see alpha as a measurement of the value added or subtracted by a fund's
manager. There are limitations to alpha's ability to accurately depict a manager's added or
subtracted value. In some cases, a negative alpha can result from the expenses that are
present in the fund figures but are not present in the figures of the comparison index. Alpha
is dependent on the accuracy of beta: If the investor accepts beta as a conclusive definition
of risk, a positive alpha would be a conclusive indicator of good fund performance. Of
course, the value of beta is dependent on another statistic, known as R-squared.
Sharpe Ratio: The Sharpe ratio is a single number which represents both the risk, and return
inherent in a fund. As is widely accepted, high returns are generally associated with a high
degree of volatility. The Sharpe ratio represents the trade off between risk and returns. At the
same time, it also factors in the desire to generate returns, which are higher than risk-free
returns.
Mathematically, the Sharpe ratio is the returns generated over the risk-free rate, per unit of risk.
Risk in this case is taken to be the fund's standard deviation. A higher Sharpe ratio is therefore
better as it represents a higher return generated per unit of risk.

However, while looking at Sharpe ratio, please keep in mind that it being only a ratio, is a pure
number. In isolation it has no meaning. It can only be used as a comparative tool. Thus the
Sharpe ratio should be used to compare the performance of a number of funds. Alternatively,
one can compare the Sharpe ratio of a fund with that of its benchmark index. If the only
information available is that the Sharpe ratio of a fund is 1.2, no meaningful inference can be
drawn as nothing is known about the peer group performance. Secondly, it may be misleading at
times. For example, a low standard deviation can unduly influence results. A fund with low
returns but with a relatively mild standard deviation can end up with a high Sharpe ratio. Such a
fund will have a very tranquil portfolio and not generate high returns.

Beta: Beta is a statistical tool, which gives you an idea of how a fund will move in relation to the
market. In other words, it is a statistical measure that shows how sensitive a fund is to market
moves. If the Sensex moves by 25 per cent, a fund's beta number will tell you whether the fund's
returns will be more than this or less.

The beta value for an index itself is taken as one. Equity funds can have beta values, which can
be above one, less than one or equal to one. By multiplying the beta value of a fund with the
expected percentage movement of an index, the expected movement in the fund can be
determined.

Thus if a fund has a beta of 1.2 and the market is expected to move up by ten per cent, the fund
should move by 12 per cent (obtained as 1.2 multiplied by 10). Similarly if the market loses ten
per cent, the fund should lose 12 per cent (obtained as 1.2 multiplied by minus 10). This shows
that a fund with a beta of more than one will rise more than the market and also fall more than
market.

But please note that beta depends on the index used to calculate it. It can happen that the index
bears no correlation with the movements in the fund. For example, if beta is calculated for a
large-cap fund against a mid-cap index, the resulting value will have no meaning. This is
because the fund will not move in tandem with the index. Due to this reason, it is essential to
take a look at a statistical value called R-squared along with beta.

The R-squared value shows how reliable the beta number is. It varies between zero and one. An
R-squared value of one indicates perfect correlation with the index. Thus, an index fund
investing in the Sensex should have an R-squared value of one when compared to the Sensex.
For diversified equity funds, an R-squared value greater than 0.8 is generally accepted to mean
that the underlying beta value is reliable and can be used for the fund.