Fund’s Risk Return Profile

Hey, want to start investing? Mutual funds can be a very amazing option for you. But it’s impossible without risk factors. The best way to overcome the risk is to always evaluate a fund’s risk-return profile before you initiate the investment. There are a lot of people who invest in equity funds rather than investing in debt funds, well, it all depends on personal financial goals. However, you must know before investing that equity funds are riskier than debt funds as the returns are always linked to market performance.

For example, you will be a risk-seeker if you have multiple asset disposals compared to fewer liabilities. In this category, you will have an emergency fund, enough retirement capital, and almost no loan.

Here in this blog, we’ll be exploring the ways that will help you measure how risky or risk-free the fund is. So let’s jump into the topic first.

• Standard Deviation

With the help of SD or standard delineation, you can understand the volatility of a fund and make your investment plans accordingly. So if you are looking for predictable returns then go for funds with low standard deviation, such as hybrid funds. But if you’re comfortable with the ups and downs then you can certainly choose funds with high standard deviation such as sectoral funds, thematic funds, small cap funds and others.

• Sharpe Ratio

To understand and compare the risk-adjusted returns of two or more mutual funds this Sharpe ratio is generally used. There is a calculation for the Sharpe ratio, that is (fund’s return – risk-free returns) / standard deviation. When you do the calculation you get a clear idea of how much excess returns you are getting for every unit of risk that your fund is bringing to your portfolio. Before making any kind of investment in mutual funds, checking the percentage of Sharpe ratio is a must-do, if you want to minimize the riskiness and safely get the returns. 

•     Sortino Ratio

The concept of the Sortino ratio is very similar to the Sharpe ratio. The only difference between these two matrices is Sharpe ratio focuses on both the up and downside of standard deviation but the Sortino ratio only focuses on the downside of standard deviation. To calculate this ratio you need to know the formula first, (fund’s return – risk-free returns) / downside standard deviation. When the Sortino ratio is higher it means the fund has a better potential to earn more returns by not taking unwanted risks. That’s why Calculating this ratio is extremely beneficial when the market is extremely volatile. So select your fund accordingly.

• Jensen’s Alpha

The modified version of financial matric alpha is known as Jensen’s Alpha. This metric is used to measure the performance of an investment related to a benchmark index. To be more specific it can also help at measuring the excess return compared to the estimated return. The formula to calculate Jensen’s alpha is Portfolio Return – [ Risk-free Rate + Beta* (Expected Market Return –  Risk-free Rates)]. If Jensen’s alpha is higher then risk-adjusted returns will be also higher. When it comes to evaluating a fund’s risk profile alpha is one of the most common matric.

• Beta

Just like alpha, it is also a common finance matrix one must calculate to evaluate the risk-return profile. To understand how volatile a fund is compared to its benchmark, this Beta is used. There are some indications of beta. The beta of 1 means stocks are moving in line with the market. When Beta is more than 1 it means that stocks are more volatile or more fluctuating. Beta less than 1 means less volatility in stocks and a negative beta indicates when stocks are moving in the opposite direction of the market. So before you invest check the beta and make a more secure investment. To calculate beta follow the rules first, (Fund Return – Risk-free Rates) / (Benchmark Return – Risk-free Rates

• Treynor Ratio

Traynor ratio is a little bit similar to the Sharpe ratio. The Sharpe ratio adjusts risks using standard deviation, but the Treynor ratio uses beta just to adjust for systematic risk. This systematic risk is a general risk that is linked to the stock market. To calculate this ratio, always remember the rules first. Treynor Ratio = (Average Portfolio Return – Average Risk-free Rates) / Beta of the portfolio. The higher the Treynor ratio you’ll get the better result you’ll receive from the investment. If you want to minimize the riskiness of a fund then also go for a higher treynor ratio.

Benefits of Evaluating Risk-Return Before Investing

If you have comparatively lower risk-tolerance capacity, then evaluating risk-return is a basic need. Using the metrics we’ve discussed you can certainly do so. Here are some special benefits you may get once you start measuring the mutual funds. These benefits are,

1. Once you start evaluating the funds using the above-discussed risk metrics such as SD, sharpe ratio, sortino ratio and others you get a better insight into a fund’s performance.

2. Using these metrics you can compare multiple mutual funds at a time and lastly you’ll be able to select the most suitable fund that meets your investment goals.

3. If you are looking for a diversifying portfolio then also it will help you a lot. If you understand the risk level of different kinds of funds, you’ll automatically learn to balance the high-risk and low-risk funds, so accordingly you can create a diversifying portfolio for yourself.

4. Moreover, by evaluating the fund you make more informed investment decisions. As you can assume the risk. But always remember mutual funds are always subject to the stock market, so uncertainty will always be there.

To Wrap Up

Nowadays finding the data of any fund is no longer a difficult task. If you’re aware of the matrics you can do it on your own. Before you start investing, do your homework, do deep research, and make decisions sincerely as investing in MF is just like making long-term relationships.

Please share your thoughts on this post by leaving a reply in the comments section. Contact us via phone, WhatsApp, or email to learn more about mutual funds, or visit our website, Prodigy Pro. Alternatively, you can download the Prodigy Pro app to start investing today!

Disclaimer – This article is for educational purposes only and does not intend to substitute expert guidance. Mutual fund investments are subject to market risks. Please read the scheme-related document carefully before investing.