How to Pick Best Mutual Fund Schemes with Alpha and Beta Ratios?
If you are selecting a specific stock for long term investments, you would do fundamental and technical analysis. However, if you are investing in mutual funds, you would generally go with past performance and how it was able to perform in various market cycles. There are several ratios which mutual fund experts consider in recommending best mutual fund schemes for long term investment. Some of the ratios are Alpha and Beta in Mutual Funds that can help you to pick-up right mutual fund scheme to invest. What are Alpha and Beta in Mutual Funds? How you can pick-up best mutual fund schemes with Alpha and Beta? How you can assess about the volatility of your mutual fund schemes with these ratios? How you can pick-up a high risk and high return mutual funds with these ratios?
Also Read: Do you know 7 Types of SIPs in Mutual Funds that can help you to grow your money?
How do you pick-up mutual fund schemes?
Generally, we pick-up mutual fund schemes based on any of the following criteria
1) Mutual Fund schemes that outperformed in the short term, medium term and long term.
2) Mutual Fund Schemes that have good credit rating from Value Research, Crisil and Morning Star.
3) Mutual Fund schemes recommended by MF experts.
4) Mutual Fund schemes that are expected to outperform based on decision making by Government (e.g. Thematic sector funds like Infra funds or banking funds).
5) Mutual Funds with Sharpe Ratio etc.,
However, none of these criteria would help to know mutual fund investor, how such schemes would perform in volatile markets or how well these would perform in bull run or bear run. Here come Alpha and Beta ratios. Just look at the various parameters indicated below where one would consider while selecting a good mutual fund scheme including Alpha and Beta.
What is Alpha in Mutual Funds?
In simple terms, Alpha is used as a measure of performance against a benchmark or a market index over a specified return. It indicates whether a portfolio manager has managed to beat the market return over the expected. Alpha can be seen as a measure of the fund manager’s performance. This indicates that what the fund has performed over (or under) its expectations.
It is commonly used to rank active mutual funds as well as other types of investments. Positive alpha represents the contribution a fund manager has made for the fund’s return. It implies that the fund has performed better than expected. So, higher the alpha, better the returns. It is often represented as a single number
Alpha in Mutual Funds explained with an example
Alpha is often considered to represent the value that a portfolio manager adds or subtracts from a fund’s portfolio return. An alpha of 1.0 means that the fund has outperformed its benchmark index by 1%. In the same way, an alpha of -1.0 would indicate an underperformance of 1%. For investors, the higher the alpha, the better it is.
What is Beta in Mutual Funds?
A Beta is a statistical tool which tells us about the relative volatility of a mutual fund as compared to its particular market index and thereby denotes the risk profile of the mutual fund.
Beta measures the sensitivity of the funds to its index. It shows the relation between the fund’s returns and that of its index. The Beta value for the corresponding market for the mutual fund is taken as 1. Any value more than 1 denotes more volatile and a value less than 1 denotes less volatile. Beta is basically a measure of volatility. A 1.2 beta fund is more volatile than a fund with beta 1. It warns the investors to invest in funds with high Beta.
Beta in mutual funds explained with an example
A beta of 1.0 indicates that the price of an investment will move in lockstep with the market. A beta of less than 1 indicates that the investment is less volatile than the market. Correspondingly, a beta of more than 1.0 indicates that the price of an investment will be more volatile than the market. For instance, if a fund portfolio’s beta is 1.2, theoretically it is more 20% more volatile than the market.
Talking about a specified mutual fund, take HDFC small cap. Its Beta value is 0.8. This indicates that if Nifty Midcap 100 moves up 10% in one month, this fund moves up by 8%. On the other hand, if Nifty losses by 10%, this fund loss by 8%.
Can we choose a good mutual fund scheme with Alpha and Beta?
Alpha and Beta are extensively used by the investment managers to calculate, compare and analyze returns. While selecting the mutual funds, the investors need to use mutual fund alpha and beta as per the risk profile. Low-risk appetite investors should look for a mutual fund with lower Beta and investors willing to take more risk in search of higher returns should look for high beta investments. While everyone wants to opt for mutual funds with higher alpha and lower beta but they need to understand that it is difficult for a mutual fund manager to generate higher alphas without corresponding higher Beta.
A knowledgeable and goal-oriented investor would both the tools efficiently to pinpoint best mutual funds. Alpha tells you whether a particular fund has produced returns justifying the risks it is taking by comparing its actual return to the one predicted by the beta. For example- a fund can be expected to earn a return of 15% in a given year based on its beta. However, it fetches you the return of 18%. Then, the alpha of the fund is simply 18-15=3.
Samples about Low Beta and High Alpha Mutual Funds in India in 2019
1) HDFC Small Cap Fund has a beta of 0.7 and Alpha of 8.0.
This means, if NIFTY Smallcap 100 (fund benchmark) increases by 10%, this fund would provide 18% returns (8% higher i.e. with 8 Alpha).
If NIFTY SmallCap 100 falls by 10%, it would fall only by 7% (0.7 beta).
2) Mirae Asset Large cap Fund Direct plan has beta of 0.93 and Alpha of 3.31.
If NIFTY 100 (Benchmark for this fund) increased by 10%, this fund would provide 13.31% (3.31 Alpha).
If this benchmark crashes by 10%, this mutual fund would fall by 9.3% (0.93 Beta).
If you want to take high risk and looking for high returns from mutual funds, you can invest in high Alpha and Low Beta Mutual Fund schemes that can fetch you good returns. We would be filtering such funds in coming week’s articles.
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How to pick Best Mutual Fund Schemes with Alpha and Beta Ratios
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Dear Suresh Ji,
I am planning to invest in the following funds and create a portfolio for 20 years to achieve my retirement goal. Wanted to generate corpus of ~2 Cr for that.
Monthly investment of Rs. 2,000 in each fund (total 5 funds)
1. Axis focused 25 fund – Growth Direct
2. Axis Blue Chip Fund – Growth Direct
3. Mirae Asset Emerging Bluechip Fund – Growth Regular
4. SBI Small Fund – Growth Direct
5. Franklin india freeder – US opportunity fund – Growth Regular
Are these funds and fund allocation good for my goal? If not please suggest any alternative suitable fund.
Hello Mridhul, you are investing in bluechip, largecap, midcap, smallcap and international fund which diversifies your portfolio. You can add balanced mutual funds also into your list when you add new investments
Thanks for the excellent article, can you please provide list of best performing multicap funds suitable for medium to long term investment
Hello Sathish, I have reviewed top multicap mutual funds and here is the link. You can consider any of these funds. https://myinvestmentideas.com/2019/04/best-multicap-mutual-funds-to-invest-in-2019/
Hello Suresh Sir,
I really love reading your investment idea articles and your personal response to it is cherry on the cake.I had subscribed your blog 3 years back and also shared with my friends and colleagues.
I request you to please review my investment and suggest if it requires any modification. This would be really helpful
Annual Salary – 9.5 LPA
Home Loan – 62 Lacs (60% EMI is paid by me – Rs 27128)
PPF – Rs 5000 yearly
Term Life – Aegon – Rs 9956 yearly
LIC – Jeevan Akshay – 2 policies
Rs 7666 half yearly
Rs 4838 half yearly
7 ELSS Mutual Funds:
Axis Long Term Equity Fund – Growth – Direct
Start Date: 22/02/2016
End Date: 22/02/2066
ABSL Tax Relief ’96 Fund – Growth – Direct
Start Date: 20/03/2016
End Date: 20/03/2021
DSP Tax Saver Fund – Growth – Direct
Start Date: 28/02/2017
End Date: –
Franklin India Taxshield – Growth – Direct
Start Date: 25/02/2017
End Date: 31/12/2099
Tata India Tax Savings Fund – Growth – Direct
Start Date: 01/06/2018
End Date: 18/06/2050
Invesco India Tax Plan – Growth – Direct
Start Date: 24/02/2019
End Date: 24/02/2026
L&T Tax Advantage Fund – Growth – Direct
Start Date: 15/03/2019
End Date: 15/03/2026
Thinking of buying Health Insurance for parents – around 45000 yearly
Rupesh, Good to hear about you 1) Aegon Life insurance is good 2) You have invested in LIC Jeevan Akshay which is pension plan. You should understand that LIC plans provides 5% to 6% returns and don’t expect more than that. If you are still okay with such returns, you can continue, else exit such plans 3) Looks you heavily invested in ELSS funds. These funds are good, however I would advice you to limit such funds to 2-3 and invest balance in other equity mutual funds. 4) If you are looking for some good health insurance for your parents, look at this article which can provide some tips. https://myinvestmentideas.com/2016/08/best-health-insurance-plans-for-senior-citizens-or-elderly-parents/
Thank you for the simple explanation, it really helps. I have following queries:
How often the Alpha and Beta change? On what basis the fund manager keeps updating them?
Also, do Alpha and Beta values for Debt MFs mean something else? When I list Banking & PSU Debt Fund in valueresearchonline website, they show very strange values. For e.g. Axis Banking & PSU Debt fund shows Alpha of 9.54 and Beta of 4.11! How should I interpret these numbers?
Hello Rajagopal, These behaves strange when some sectors or funds go crazy for several reasons. You can compare with other funds in similar category to understand them better (is it exceptional or some computation error etc.)