A closer look at key quantitative measures can reveal how a fund is managed, the level of risk it takes, and its consistency across market cycles. What are these measures and what do they say about the scheme?
Turnover ratio
The portfolio turnover ratio is the percentage of investments a fund manager replaces in a mutual fund scheme over a year.
A low turnover ratio might indicate that the fund manager follows a ‘buy and hold’ strategy and invests for the long-term.
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A high turnover ratio may not necessarily be a bad thing, as some fund managers prefer to take profits from their investments at regular intervals, which can show up as higher turnover ratio. However, a high turnover ratio with poor returns can be worrying. It might mean that the fund manager is unsure about his or her investment strategy.
Sharpe ratio
The Sharpe ratio measures how much excess return a mutual fund generates for each unit of risk taken.
By comparing the fund’s returns to risk-free assets like short-term government bonds, it helps investors assess whether higher returns come from smart investment choices or simply from taking on more risk.
“A scheme may have a high sharpe ratio due to outperformance. However, some schemes with high sharpe ratios may be taking higher risks, especially in certain market conditions,” said Ravi Kumar TV, co-founder of Gaining Ground Investment Services.
The sharpe ratio isn’t a standalone metric—it gains meaning when viewed in the context of the fund’s investment universe, category, and prevailing market conditions.
“During bull markets, mid- and small-cap schemes often show higher sharpe ratios due to strong performance, but this does not always imply lower risk. Investors should analyse whether a high sharpe ratio comes from skillful fund management or excessive risk-taking, which could backfire in weaker market conditions,” Kumar said.
Beta
If the scheme’s beta is more than 1, it means that it is more volatile than the index. If it is just 1, it means the scheme is perfectly correlated to its benchmark index and will move higher or lower to the extent the index moves.
For instance, all index schemes have a beta of 1, as these schemes simply track benchmark index.
If a scheme’s portfolio is deliberately kept similar to index, it may result in beta that is closer to 1. In the case of an actively-managed scheme, it means the scheme is geared to deliver index-like returns, despite charging higher fees for actively-managed scheme.
If the beta is less than one, it means scheme is less volatile than benchmark index.
Standard deviation
Standard deviation quantifies how much a scheme’s returns fluctuate from its average, offering insight into its volatility over time.
Higher standard deviation means greater swings in performance, while a lower value indicates more stability.
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But it is important to check the scheme’s standard deviation over different periods and phases of the stock markets.
“One caveat: standard deviation does not distinguish good and bad volatility as it takes into account both negative and positive returns from the average. Hence, it should be looked at in combination with other ratios,” points out Rushabh Desai, founder of Rupee with Rushabh Investment Services.
Beyond ratios & measures
The above quantitative measures give certain indications about the equity scheme, but also have their limitations. These measures need to be complemented by other tools.
For instance, look for the scheme’s returns across different market cycles. Instead of the conventional point-to-point returns, consider rolling returns.
Rolling returns eliminate the starting- and ending-point bias. A scheme’s returns might show up higher or lower, depending upon the start- and end-point – across one-year, two-year, three-year, five-year or ten-year periods. A scheme may have outperformed in one-year period, but may have negative returns in five-year period.
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On the other hand, rolling returns roll these time-period returns on a daily basis, and then averages out these observations. As a thumb-rule, longer time-period analysis shows a scheme’s past performance across more market cycles.