Mutual Fund and Risk Ratios

Mutual Funds
Mutual Funds are the most convenient way to invest in stock markets and Indian investors have started to realise this. That’s the good news; the bad news is that a lot of investors seem to think that mere decision of investing in mutual funds will do the “trick”. Some important points are generally neglected or ignored at the end of an investor, which may prove to be hazardous for his investments. I have tried to bring few of them to your notice. Mutual funds are often touted as a useful vehicle for small investors as it allows an investor to hire an expert known as fund manger, a fund manger go through a plethora of parameters for evaluating among the thousands of stock listed on the stock exchanges.
The standard approach is to look at the past performance of the fund, the risk associated with the fund, the conduct of the fund house, service of the fund house, the adherence to or the deviation from the objective of the scheme etc. Looking at these parameters is important, but there is another perspective, that needs to be look at. Every fund house or every fund manager has a particular style of working, certain values and certain appetite for risk. Some funds are aggressive, while some are conservative. You are the best judge to match your investment according to your risk and return profile.
You may invest in the best mutual funds consistently, but unless you encash gains at some point, they remain merely on paper and you don’t reap any benefits. Sometimes it may even be a loss that warrants your exit. It’s ok if your fund’s underperformance is an aberration, but when this become regular, it’s time to say good-bye to the fund. A fund may loose focus, or may find its chosen path difficult to walk over a period of time and hence decide to change its course. But, when your fund does it too often, its bad news for your investment.
Most of you must have heard the phrase “timing the market” in the context of investing in equity market or mutual fund. But, for serious investors, who are investing for longer duration for a broader financial planning objective, this should be of no relevance. Unfortunately, there are so many long-term investors, who before investing in the equity funds wait for the markets to decline so as to invest at lower levels. If investors had been waiting for a decline in the last four years, they would have been waiting on the sidelines for most of the time, because of the strong secular run up in the markets over this time frame. Regardless of stock market levels, a long-term investor should focus on their investment objective, rather than concentrating on stock market ups and downs.
You should also know that how much is the cash holding of the mutual fund, for fund managers sitting on huge cash is a favoured strategy to combat volatile markets. Larger cash holding may also indicate that funds are not being deployed at the pace that they are flowing in, indicating paucity of investment opportunities. If you have invested in a fund house whose size is growing, but the growth is accompanied by larger cash holdings you could consider suspending further investments and instead monitor the ability of the fund management to identify investment opportunities in current market conditions.
An investor should also keep an eye on the portfolio of the mutual fund scheme in which he is going invest or planning to invest his hard earned money. The portfolio of the scheme should be diversified upto some extent because over diversification can also drag the returns down. While analysing a scheme, an investor should ensure that the diversification in the top 10 holding stocks of the equity scheme should not have more than 35-40% exposure of AUM. This may also help a fund manager to adjust the volatility more effectively than its peers. Plus another point to be noted while assessing a portfolio of the scheme is that the scheme should not have a focused portfolio across a few sectors. This would imply that the fund is not totally diversified and the risk involved in the fund is increased when the market is inclined to volatility.
While assessing a mutual fund scheme, it is not just important to assess the returns only, but it is also important to look at the risk involved in the mutual fund scheme. The risk involved in the fund can be assessed on analysis of various risk ratios, some of them are:
Beta:
Beta is a measure of volatility. It is a fund’s volatility measured against the benchmark index, which is set to be 1. Therefore, if a fund has a Beta higher than 1, it is moving up and down more than the rest of the market. A fund with a beta of 1.0 should mirror the index’s movements. A fund with a beta of 1.1 should move 10 percent higher than the index in up markets, and 10 percent lower in down markets. A fund with a beta of 0.9 should move 10 percent less than the index in either direction.
Sharpe Ratio:
Sharpe Ratio was developed by William Sharpe to measure risk-adjusted performance. Simply put, it is a “Risk to Reward Ratio”. It is calculated by subtracting the risk-free return from the rate of return for a portfolio and dividing the excess return of a fund over the risk free rate by its standard deviation.
Standard Deviation:
Standard Deviation measures the fund’s volatility in percentage. Standard Deviation measures the average performance of the fund’s returns over a time period. Stable investments like money market funds have standard deviation near zero, while high-risk equity funds often have a much higher standard deviation.

In the last two year the mutual fund industry has shown a rapid growth, the asset under management in mutual fund industry has shown a growth of more than 33% per annum.  India is a developing economy and second fastest growing economy in the world with the GDP growth of 9.2% per annum, it provides numerous opportunities to the fund manager to invest in the under valued stocks. Govt. of India is planning to invest the pension funds of the govt. employees in the stock market, through the route of mutual funds. Number of foreign AMC’s are in the que to enter the Indian markets like Lazard Group, The UK-based investment bank, is expected to enter the Indian asset management business through Lazard India and Mirae Asset Management, the largest mutual fund house in Korea, is in the process of getting regulatory approvals from SEBI to launch its asset management operation here.
The saving rate of Indian is the highest saving rate in the world around about 23-25% of the income, as now most of the investors are aware about the mutual funds and willing to invest in mutual fund according to their risk taking capacity rather to put them into bank fixed deposits. ‘B’ and ‘C’ class cities are growing rapidly. Today most of the mutual funds are concentrating on the ‘A’ class cities. Soon they will find scope in the growing cities.
India is the largest consumer of gold in the world and India contributes 35-40% of the world total demand for physical Gold. In India people buy most of physical gold from investment point of view, and in the current year the concept of gold Exchange Traded Fund (ETF) knock the door of Indian mutual fund industry, three mutual fund companies already launched the Gold ETF and other fund houses are in a que for launching it. Due to the launch of gold ETF, most of the investors may invest in the golf ETF not in the physical gold, which will help the mutual fund industry to grow further. Investment in the ETFs was first come into effect from America, in the beginning years the concept of the gold ETFs were failed due to low trading volume but now more then 60% trade in the American stock exchange has come from the ETFs. SEBI allowing the MF’s to launch commodity mutual funds.