Mutual Fund Risk and Return Analyzer

Published: May 30, 2014 at 11:00 am

Last Updated on

Tired of confusing and ever-changing mutual fund star ratings? Would you like to rate and rank a mutual fund with respect to its benchmark for investment durations ranging from 1-8 years on your own?

Here is a risk and return analyzer for equity mutual funds with which you can

  • Determine SIP and lump sum returns
  • Evaluate performance taking into account the risk taken for the return achieved
  • Compare
    • Fund versus benchmark (31 indices from BSE and NSE)
    • Fund and benchmark performance wrt a risk–free rate that you choose for each investment duration
    • Fund and benchmark performance wrt a minimum acceptable rate that you choose for each investment duration
  • A percentage score is assigned to the fund for each investment duration based on 12 different risk/return metrics (a total of risk and return 16 benchmarks)

This analyzer can be used by ALL retail investors. NO knowledge of risk and return analysis is required to use the sheet and understand the results!

Obviously a basic understanding of the metrics used (see below) will help.

Credits: The risk/return metrics calculations were possible, thanks to the excellent tutorials available at investexcel.net

This sheet is an adaptation of the Multi-Index Mutual Fund SIP/Lump Sum Returns Analyzer

The following Indices are available for comparison:

NSE: CNX Nifty, CNX Mid Cap, CNX 500, CNX 100

The NSE server is not Excel friendly.  So data for these indices from April 2006 to Oct 2013 is stored in the file. Data from Oct. 2013 to-date is obtained from Yahoo Finance.

BSE: All 27 indices!

For each investment duration (1Y … 8Y), the funds performance with its benchmark is evaluated with a post-tax risk free return (fixed deposit interest rate for example) and a minimum acceptable return.

The performance is graded as a percentage for easy understanding.

A score of 100% is of course the highest and represents the best performance with minimal risk.

The focus here is on risk adjusted performance when compared with its benchmark. The idea is to point out that even funds that are supposedly ‘poor’ performers are actually decent ones when evaluated in isolation against its benchmark

Here are some examples of this score plotted against the investment duration for some popular mutual funds.

The risk-return score appears to be reasonably good in spotting a drop in performance. I will write more about this as I understand it better.

Please have a look and share in the comment section your impressions.

If you need some help in understanding these results, you can always write to me or seek advice in a good forum, like facebook group, Asan Ideas for Wealth.

The advantage of using this tool is that it evaluates risk/return performance for eight different durations. The user can input a post-tax risk-free rate like a fixed deposit rate instead of using the coupon rate of an obscure 90-day treasury bill.

Since the sheet is ‘open-source’ the user understands what is happening and modify or add more metrics as per convenience. For someone wanting to learn more about risk/return performance metrics this is a one-stop shop.

Risk/Return metrics used

Here is a list of the risk and return metrics used with a simple explanation of what they refer to

1. Beta  is a volatility measure and tell us how much the fund changes for a given change in the index. A beta of 1 implies the fund movement is identical to the index movement. A beta of 0.9 implies the fund is 10% less volatile than the index.

Lower the beta, lower the volatility

The analyser awards 1 point to the fund for beta <1

2. Standard deviation is a volatility measure and tell us, for a given set of returns (daily returns in this case), how much do individual returns deviate from the average. This is calculated for both the fund and the benchmark.

Lower the standard deviation, lower the volatility

The analyzer awards 1 point to the fund if its standard deviation is lower than the benchmark

3. Alpha  is a risk adjusted performance measure. It takes into account, the average return of the fund and its benchmark, a risk-free rate defined by the user and how the fund responds to swing in the benchmark (Beta)

Higher the alpha, higher the outperformance of the fund.

The analyzer awards 1 point if alpha >0

4. Sharpe ratio  is a risk adjusted performance measure. We calculate the excess returns of the fund wrt a risk-free rate. The ratio is the average of the excess return and the standard deviation of the excess return. This is calculated for both the fund and the benchmark.

Higher the Sharpe ratio, better is the performance (higher returns + low deviation from average return)

The analyzer awards 1 point to the fund if its Sharpe ratio is greater than its benchmark

5. Sortino Ratio  is a risk adjusted performance measure. The Sharpe ratio considers both positive and negative excess returns (wrt risk free rate). The Sortino ratio considers only the negative excess returns while calculating the standard deviation. There should be enough negative excess return data points to justify the use of the Sortino ratio. To take care of this, daily returns are used (instead of monthly returns as done by AMCs/fund portals).

Higher the Sortino ratio, better is the performance (higher returns + low negative deviation from average return)

The analyzer awards 1 point to the fund if its Sortino ratio is greater than its benchmark

Two types of Sortino ratios are calculated:

  • Using risk-free rate
  • Using minimum expected return (set this to zero to find out how efficient is the fund/benchmark is wrt losing money)

6. Treynor Ratio  is known as the reward to volatility ratio. While the Sharpe ratio is the excess return (wrt risk free rate) divided by standard deviation, Treynor ratio is the excess return divided by beta. This is calculated for both the fund and the benchmark for which beta is assumed to be 1.

Higher the Treynor ratio, better is the performance (higher returns + low volatility wrt benchmark)

The analyser awards 1 point to the fund if its Treynor ratio is greater than its benchmark

7. Information Ratio  This take the average excess return obtained compared to a benchmark and divides it by the standard deviation of excess returns.

Higher the information ratio, higher the consistency in beating benchmark

Accoding to Samir (who runs investexcel),

The Information Ratio is often used to distinguish between several funds with the same management style.  For funds with similar values of alpha, a higher Information Ratio indicates a better managed fund with superior stock picking. However, this is only valid if the fund and its benchmark are strongly correlated. Negative Information Ratios can be misleading and should not be used to rank investments.

Can this be used to compare funds like HDFC Equity and HDFC Top 200? Got to try this out to understand better.

Since the information ratio is slightly more complex to interpret, the analyzer awards 1 point to the fund only if the ratio greater than zero, SIP and lump returns are both greater than the benchmark

8. Omega Ratio  To calculate this, you determine all returns that are above a certain minimum acceptable return (input by user and different from risk-free rate). Then you determine all return below this return. Divide the former by the latter.

When the omega ratio is greater than 1, more returns are greater than the minimum return. This is calculated for both the fund and then benchmark.

The analyzer awards 1 point to the fund if its omega is greater than the benchmarks.

9. Downside deviation This can be thought of as a measure of ‘bad’ risk. It is the standard deviation of negative excess returns (wrt both the risk-free rate and minimum acceptable return)

If the fund has a lower downside deviation than its index, the analyzer awards the fund 1 point.

10. Upside potential  This can be thought of as the opposite of downside deviation – a measure of ‘good’ risk. That is returns obtained above a reference return (both risk-free return and minimum acceptable return).

If the fund has higher upside potential than its index, the analyzer awards 1 point to the fund.

11. R-squared This is a measure of how correlated the funds NAV movement is with its index. A value of 1 represents perfect correlation. Investors should not have multiple funds with a strong correlation with the same index.

This measure is not part of the grading system.

12. SIP returns If the funds SIP return is above the index return, 1 point is awarded.

13. Lump sum returns If the funds lump sum return is above the index return, 1 point is awarded.

Mutual-Fund-SIP-returns-risk-analyzer-Apr-2015 Removed the dependence on BSE servers. More details here

Mutual-Fund-SIP-returns-risk-analyzer-Jan-2015 Calculates lump sum investment value. Suggested by Sundarajan

Download the mutual fund risk and return analyzer (June 12 2014)

Updated with the Ulcer Index

Download the Mutual Fund Risk and Return Analyzer (June 4th 2014)

Updated with upside and downside capture ratios

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