Understanding Alpha & Beta In Mutual Fund4 min readReading Time: 3 minutes
In the world of Finance and Investments, many times you must have come across words like Alpha and Beta, they might sound complicated and overwhelming at the start but once you get a hang of it, they are quite easy to measure and understand.
This article will give you an exact overview of Alpha & Beta in Mutual Fund and its importance. As an investor, one of the most important thing to consider when investing is the correlation between your risk and returns.
Surely getting higher returns should be the priority, but when you go for higher returns, the risk eventually increases. Not everyone can make high-risk returns & investments, many times the investors are risk-averse in nature and would prefer putting all their capital in fixed deposits.
But, how exactly can you calculate the relationship between risk and returns? Well, there are many parameters that help in calculating the risk, One such method is the Alpha and Beta Approach that many experts use!
Alpha & Beta Overview
What is Alpha?
Alpha is used to measure the performance of the asset manager. It compares the efforts of a fund manager in driving the fund that he or she manages to a benchmark index. In the case of mutual funds, the baseline for Alpha is 0.
If alpha is negative, it suggests that the fund manager’s performance was unsatisfactory. If alpha is positive, it indicates that the fund manager outperformed the market. In general, the performance of a mutual fund is compared to the performance of an index.
What is Beta?
Beta is used to measure the volatility, meaning if the beta is negative, then volatility will be low and if Beta is positive then volatility will be higher. It is used to measure how stable a mutual fund is compared to the broader markets in general.
In the case of mutual funds, the beta baseline is 1. If beta is one, it means that the mutual fund exhibits the same fluctuation as the benchmark index. If it is greater than one, it indicates that the fund’s value has changed dramatically as compared to the benchmark. If beta is less than one, it suggests that the fund’s value fluctuates less than the benchmark index.
Importance of Alpha & Beta
A good mutual fund is the one that gives us better returns, given the same risk. But, before investing in a mutual fund, it’s important to understand how it’s performed in the past.
As a reminder, past performance has no bearing on future performance. Nevertheless, it’s always a good idea to check the past performance of the fund so you can get to know the fund manager and his performance over the various market phases.
Provides Vital Data:
Alpha and Beta in mutual funds can be used to compare the performance to a benchmark. They also provide vital data for evaluating future growth, risk, and volatility.
Alpha for Investors:
For investors, alpha is useful in deciding if a mutual fund is worth investing in because it gauges the fund manager’s ability to make profits. As a result, understanding how the fund manager has performed allows them to make an informed decision.
Beta for Investors:
Similarly, beta assists investors in knowing how responsive the mutual fund was when markets were turbulent. By examining the beta of a mutual fund, investors can determine whether or not the fund in which they are considering investing is suitable.
Beta for Risk-Averse Investors:
Investors who are risk-averse in nature would want a lower beta since it indicates consistent returns and response to market volatility.
Alpha for Risk Takers:
Investors who are risk-takers in nature and are usually looking for higher returns would want to see Alpha always above 1.
From the above article, we understood that higher alpha is considered good, while the same cannot be considered for the Beta coefficient. Investors must always look into these risk ratios before investing in any mutual funds.
ICICI Prudential Alpha Low Vol 30 ETF FOF: An open-ended fund of funds (FOF) that focuses more on growth and stability. It is a long-term wealth creation with the primary objective of generating higher returns by investing in units.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully. Such representations are not indicative of future results. Paytm Money Ltd SEBI Reg No. INA100009859 Regd Office: 136, 1st Floor, Devika Tower, Nehru Place, Delhi – 110019. The NFO offering is non Exchange traded products and Paytm Money Ltd (PML) is acting as an agent for distributing the same. Please note all disputes with respect to the distribution activity, would not have access to the Exchange investor redressal forum or Arbitration mechanism. The securities quoted are exemplary and are not recommendatory This information is purely based on publicly available data and in no way to be considered as advice or recommendation.
Also Read: Advantages of Investing Globally