Evaluating Volatility in Returns

Published: November 7, 2014 at 10:54 am

Use this rolling standard deviation calculator to evaluate  the volatility in returns of  a mutual fund.   This is an idea that struck me during the Chennai investor meet in response to a question.

The sheet calculates the rolling return and rolling standard deviation for a specified interval. For equity funds, the rolling standard deviation of the fund can be compared with its benchmark.

One can also compare the rolling return of the fund with its rolling standard deviation.

The standard deviation is a measure of how much returns can deviate from the average return. In fact, the standard deviation is the average deviation.

Higher the standard deviation, higher the volatility in return.

The standard deviation is calculated from daily returns and then annualized by multiplying it with the square root of the number of trading days (250-252) in a year.

I have mentioned about the importance of the standard deviation in the following posts.  If you are not familiar with the term, please read these posts and then use this sheet:

Here are some screenshots.

7-year rolling return of equity fund return and standard deviation

rolling-std-3

Although the std-dev variation looks dramatic, compared to the variation in returns it is quite small. However, the standard deviation is a steady ~ 22-23% and always higher  than the return.

This means the investing in HDFC equity for 7 years is fraught with risk. The volatility in returns can result in a risk in this case since the duration is low.  Note that 7 year returns have been plotted from April 2006 only. Had it been since inception, the fluctuation in return would have been much more.

That said, the fund has a lower standard deviation that its benchmark.  Thus, the fee paid to the fund manager is justified.

rolling-std-4

This is the corresponding rolling return.

rolling-std-2

1-year rolling return of liquid fund return and standard deviation

rolling-std-5

The standard deviation of a liquid fund is 100 times lower than an equity fund!  However, due to debt market movement the spread in the returns in not proportionally lower and there is still significant volatility in returns.

That is, the actual return for a 1- year investment in a liquid fund will depend on when you started investing.  However,  it is safe to say that volatility will always be low.

For an equity fund, again the return will depend on when you start on investing. It is safe to say that, unless the duration is 15+ years, the standard deviation will be comparable to returns. That volatility will always be high.

The sharp vertical changes are due to discontinuity in dates and can be ignored. I do not know a way around this as of now.

Download the Rolling Returns + Rolling Standard Deviation Calculator

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About the Author Pattabiraman editor freefincalM. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman has co-authored two print-books, You can be rich too with goal-based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management. He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice. He conducts free money management sessions for corporates and associations on the basis of money management. Previous engagements include World Bank, RBI, BHEL, Asian Paints, Cognizant, Madras Atomic Power Station, Honeywell, Tamil Nadu Investors Association. For speaking engagements write to pattu [at] freefincal [dot] com
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