Introduction
In recent years, there has been a dramatic growth of mutual funds. This means that distinct mutual fund portfolios have doubled. Mutual funds at the moment are the most preferred way for many institutions and investors to participate in capital markets hence their popularity has raised the demand for fund performance evaluations. However, there is no any general agreement about how to both measure and compare the performance of fund and additionally what information should funds disclose to the investors. In any bond performance ranking, the two main issues, which are needed to be addressed are how we can choose a benchmark that is appropriate for comparison and how we can adjust fund’s return for the risk.
Performance and risk measurement or evaluation is essentially an active area for the academic research and it is of vital interest to all the investors who are required to make decisions that are well informed and to the mutual fund managers who are responsible for fund performance. All the performance measures measure funds’ returns that are related to risk. They however differ in the way they both define and measure the risk and, subsequently, the way they describe risk-adjusted performance. For that reason, this essay essentially evaluates the fund’s risk and the return characteristics in addition to the other qualifying information.
The statistics, which measure or evaluate mutual fund risk, are essentially fundamental to the mutual fund screening process. The investors on their part need to distinguish how risky the individual assets are in addition to how their contribution to total risk would appear.
Beta
In mutual fund analysis, beta also known as systematic risk or market risk that is essentially based on volatility of returns. In contrast to the standard deviation, systematic risk or Beta measures the volatility relative to an appropriate baseline instead to mean of asset being evaluated. Beta is actually the most appropriate measure of the contribution of an asset to an investor portfolio’s risk because it only measures the systematic risk. Beta measures the mutual fund risk relative to a certain benchmark, particularly S&P 500. Therefore, it is a measure of the systematic risk as mentioned, rather than the total risk. Just like the standard deviation, beta is in fact a variability measure.
However, Beta variability is actually relative to benchmark instead of fund’s own mean. Thus, Beta gives an investor a better idea of how is likely to move the movements of benchmark. Since it is a systematic risk measure, a portfolio’s beta simply is the weighted average of betas of assets that are held in a given portfolio; hence it provides a systematic risk measure of the portfolio. For that reason, in a portfolio that is well diversified, the systematic risk is equal to the total risk since specific risk has probably been diversified away. The beta of my fund is 1.06. This beta means that for each 1% move in S&P 500, the investor can expect his or her growth fund to move roughly 1.06% in a similar direction.
R-squared
R-Squared is a statistic that should be reported together with beta. It is generated by regression analysis that is used to derive mutual fund’s beta. This statistic is coefficient of determination that tells the investor what percentage of movement in fund is essentially explained by the movement in benchmark that is used in regression analysis. The most commonly benchmark that is utilized for this purpose is the S&P 500. The higher R-squared is, the more reliable a beta is as a probable variation measure. Additionally, R-squared is the correlation coefficient square. Thus, it gives an investor some idea about correlation degree between the benchmark and a fund. However, since the value of the square root of any number is an absolute value, it is not possible for an investor to know whether R-squared is negative or positive.
Furthermore, it does not tell an investor how a given fund works relative to the other funds in his or her portfolio. Nevertheless, R-squared is advantageous for screening since low values signpost that a given fund may possess good diversification potential hence warrants a detailed and closer looks. For my fund, the R squared statistic is 98.29. By a closer look, this statistic indicates that the fund does not possess good diversification potential since its value is high.
Alpha
Alpha is a statistic that is utilized in measuring the performance on risk adjusted basis. It is obvious that investors want to know whether they are compensated for risks that they take. Return of investment can be better than benchmark but still fail to compensate for the risk assumption. Thus, an Alpha whose value is zero means that the investment has accurately earned a return that is adequate for the assumed risk. An Alpha whose value is over zero means that the investment has actually earned a return, which has more than the compensated for taken risk.
An Alpha whose value is below zero means that the investment has essentially earned a return, which has failed to compensate the assumed risk. Risk adjusted means that a given investment return must compensate for Beta that is, volatility. Given that an investment appears twice as volatile as benchmark; the investor should get twice the return as a result of assuming the extra risk. On the other hand, if it is less volatile than benchmark; the investor should get less return than benchmark hence still be compensated fairly for amount of taken risk. The relationship between Beta investment and Alpha investment is that each one strives for an Alpha that is positive while Beta investment is actually a choice for everyone.
Therefore, understanding the dissimilarity between the two and the way they relate to the investment risks make one a better investor. The goal of each fund manager is to achieve an Alpha that is positive. As a result, a good fund manager should utilize portfolio management tools hence he or she should use diversification, asset allocation, valuation strategies, and risk management so as to achieve a positive Alpha.
Manager tenure
This is the length of time that a given manager has essentially been at the control of a mutual fund. A crucial indicator of any fund manager’s abilities in investing is a fund performance record that is long term in nature, preferable of 5 to 10 years. Investors care because they feel best served by the investment managers who have in fact proved themselves over a period of time that is extended. Thus, the more narrowly matched a tenure of the manager is with a fund performance record that is solid, the better. Morningstar gathers manager tenure data on the open end mutual funds. Thus, rolling up the tenure data by the provider company shows a provider Company fund’s average manager tenure.
% Rank within Morningstar Category
This refers to the percentile rank of the fund total return that is relative to all the funds that possess the same Morningstar Category. The most favorable or highest percentile rank is actually one and the least favorable or lowest percentile rank is in fact 100. In a category, the top performing fund will normally receive a rank of one.
Potential Capital Gains Exposure
This refers to a fund’s assets estimate of percent, which represents gains. This measures the amount of appreciation of the fund’s assets. It can really be an indicator of the distributions of the possible future capital gain.
Expense Ratio
Expense ratio is actually a measure or degree of what it costs a company that is investing to operate mutual fund. It is determined by a yearly calculation where the operating expenses of a fund are divided by assets’ average dollar value.
Turnover Ratio
This is the percentage of mutual fund or the other investment holdings vehicles, which have been replaced or tuned over with the other holdings in a certain year.
References
Sheimo, M. D. (2000). Mutual fund rules: 50 essential axioms to explain and examine mutual fund investing. New York, N.Y: McGraw-Hill.
Fabian, D. (2000). The mutual fund wealth builder: A profit-building guide for the savvy mutual fund investor. New York: McGraw-Hil
