| Click here to see the table: Different ways to look at risk |
Jensen, Sharpe, Treynor and Sortino are statistical tools used by fund managers all over the world. There are complex formulae used to arrive at these ratios, but what matters is how you read the final numbers.
The funds referred to here are not any indication of the best investment for you; what you should look at is how these ratios matter in any fund you’re looking to invest in. This set of 10 funds was put together with the help of IDBI Capital Market Services, and looks at fund performance from 18 April 2005 to 18 April 2008. Compared on returns, there is little to choose from the top 10 funds, a 2.5% point difference is what separates the top fund from the last.
| Click here to see the table: Risk vis-a-vis benchmark |
There are two ways to look at Jensen’s alpha—how much the fund has beaten its benchmark and how much risk the fund manager has taken to achieve the return it has generated. An alpha value of just above zero indicates that the fund manager has stuck to the investment mandate, which is the same as fund objective. Higher the value above zero, higher is the risk taken by the fund manager to beat the market with his stock picks. The reason for using this tool is to determine if a portfolio is earning the proper return for its level of risk. If there are two mutual funds that both have a 12% return, a rational investor will want the fund that is less risky.
An alpha of 0.8 indicates that the fund has returned 80% of the chosen benchmark. So, if a fund has Sensex as its benchmark and Sensex goes up by 10%, the fund could go up by only 8%, and if the Sensex falls by 10% then the fund could fall by 8%. DSP ML Technology.com has a high alpha, which has earned investors in the fund fabulous returns; however, it also means the fund manager has taken risks beyond the fund’s objective.
Principal Child Benefit Fund-Career Builder in the balancedequity fund list has a relatively high alpha because of the over-riding performance of equities in the time frame taken to arrive at alpha, with the possibility of an inappropriately weighted benchmark to boot. Says Mallika Baheti, mutual fund analyst at Sharekhan: “Because Jensen’s alpha analyses the fund’s performance against its benchmark, it’s a good tool to analyse fund manager’s performance.”
| Click here to see the table: Market risk or total risk |
Both Sharpe and Treynor ratios evaluate the surplus a fund earns over the risk-free fixed return, taking stock market volatility into account. Among other things, they compare a fund scheme’s volatility with that of its benchmark. As an investor you may want to know how much can you expect the value of your fund investment to fall when the stock markets take a dive—or how high can the fund returns rise in the event of a bull run. A fund with a beta value greater than one is considered more volatile than the market; less than one means less volatile. In the table Taurus Starshare, an equity diversified fund, has the highest Treynor ratio, even more than the midcap fund (Sundaram BNP Paribas).
The balanced fund in the table—Magnum—expectedly is the least volatile. This fund also has the lowest Treynor ratio and a low Sharpe value. Treynor ratio only takes into account market risk (also called systemic risk) whereas Sharpe ratio takes into account total risk (market risk plus sector/stock risk). Equity diversified schemes usually have no sector/stock risk and are exposed only to market risk. That’s why Treynor ratios of these funds is very similar— in some cases identical.
Simply speaking, the Sharpe ratio tells us whether a portfolio’s returns are due to smart investment decisions or a result of excess risk. Essentially, use this to figure out if higher returns come with additional risk. The higher the ratio, the better the portfolio’s risk-adjusted performance has been. The two ratios together can be used to rank funds’ performance but cannot judge the performance of the fund or the fund manager.
| Click here to see the table: Dissecting volatility |
The Sortino ratio is similar to the Sharpe ratio, except it uses downside deviation for the denominator instead of standard deviation. Standard deviation doesn’t make a distinction between upward and downward volatility. The distinction is important to understand and estimate since upward volatility—though not desirable— doesn’t lead to losses. It actually indicates excess returns—excess over a given benchmark or average.
It’s the downward volatility that leads to losses. Sortino ratio captures the downward volatility. This measurement is considered more objective—and some analyst say more relevant—than the Sharpe or Treynor ratios. A higher Sortino indicates lower risk and higher returns.
Notice that Sundaram Midcap has lower risk compared to Reliance Growth in the same category. The Sortino for ELSS and equity diversified funds will even out in the long term. Quite expectedly, the Sortino ratios of the two balanced funds are among the highest in the list—they have the lowest downward risk as a category. Added to that is the fact that the two fund schemes listed here are among the good balanced fund schemes.
Effectively, Sortino ratio takes forward the concept of Sharpe and Treynor by penalising funds on under-performance, thus providing a more appropriate fund evaluation tool. Also, because the ratio makes allowance for both boom and bust periods when looking at fund performance over a long term, the outcomes are far more conclusive.
Money Today separates the wheat from the chaff to identify seven gems that have done well over the long term
| Click here to see the table: Consistent long-term performers |
We’ve spent reams of paper and litres of ink telling you why you should take an active interest in your finances and why it pays to understand macroeconomic movements. And then we go and undo all that we’ve said about self help being the best help by actually providing you with a list of what we think are the seven most consistent performers. But even as you take note of this list, remember that these funds need not necessarily be good for you. Your investment horizon, your financial goals and your risk appetite should dictate your choice of funds.
Methodologywe began our search by filtering 194 diversified equity funds in the growth category (as these are for long-term wealth creation) from NAVIndia’s database. Debt-based funds were left out, as only equity can give inflation-beating returns Next, we selected only those funds that have been around for at least nine years. The past nine years have seen more than one market cycle of bear phase and bull phase with a good measure of volatility thrown in The next filter was that these funds should have at least equalled the 20% average gain of the BSE 100 in the past nine years. Just 18 funds made the cut We then removed funds that did not match the recent bull-market trends. 11 funds that weren’t in the top one-third of their investment category when ranked on the past three year returns were discarded This left us with the seven funds that weathered market vagaries and have performed consistently |
he seven funds in the table below have delivered steady returns for years now. So, regardless of any hiccups or downswing in the markets, you can’t go too wrong with one of these funds in your portfolio. The average age of these funds is 12 years, which emphasises the importance of staying invested for the long term.
While these seven funds represent a variety of fund manager style and investment objective, all have fund managers who have stuck to a clear, proven investment philosophy. That determination and focus has kept them from being swept up in short-term trends. These funds have been less volatile, though sometimes out of step with the market trends.
RK Gupta of Taurus MF and Prashant Jain of HDFC MF have been fund managers for the longest tenures; a fund manager who has a long-term relationship with the fund also ensures consistent performance.
Want to understand these ratios better and know how to use them in your investing decision? Write to us at: mtportfolio@intoday.com
