Beyond Returns: How to Analyze Mutual Fund Risk (Alpha, Beta, Standard Deviation Explained)

Factor-based funds are investment schemes that use rule based strategies to perform against the benchmark index, such as the Nifty 50 or Sensex.

Now, if you are looking to invest in these schemes, you first need to understand their level of risk and performance. This may be done by looking at three primary metrics, which are Alpha, Beta, and Standard Deviation. By making a combined analysis of these metrics, you can judge both the performance and risk of a scheme before investing. 

Want to learn how? Firstly, read this article to understand what alpha and beta mean in a mutual fund, and how standard deviation is used to measure risk. Then, learn how to analyse these three metrics together and lastly, check out some financial products you may consider for investment. 

When you invest in mutual funds, it’s important to know how the fund performs and how much risk it takes. The two key metrics that help you understand this are Alpha and Beta. 

These numbers tell you whether the fund manager is adding value and how the fund reacts to market changes. Read the table below to understand the alpha and beta meanings in mutual funds and learn how to read them:
 

Besides alpha and beta in mutual funds, several investors also calculate the standard deviation of their schemes. This allows them to understand the volatility of a fund’s performance. Let’s see how you can use it in your analysis:

For more clarity, let’s check out an example:

• Let’s say “Fund A” offers an average return of 10% with a Standard Deviation of 5. 

• Now, this means returns mostly stay between 5% (10% - 5%) and 15% (10% + 5%).

• On the other hand, there is Fund B, which offers an average return of 10%.

• It has a Standard Deviation of 10. 

• Now, its returns can swing between 0% and 20%.

Now that you know the meaning of all these three metrics, it’s high time that you learned how they work together. Please note that you can use:

• Alpha to judge performance

• Beta to measure market-linked risk

• Standard Deviation to assess relative stability

Together, these three may give you a better picture of whether the fund’s extra returns are the result of genuine skill or excessive risk. Follow this three-step process to make such a combined evaluation:

Step I: Check Alpha for “Performance”

Start by looking at Alpha. A positive alpha means the fund has outperformed its benchmark. It shows the fund manager’s ability to pick the right stocks and generate extra returns.

Step II: Check Beta for “Market Sensitivity”

Next, review Beta to understand how strongly a fund’s price changes when the market moves. If a fund has a high beta, its price fluctuates more than the market, and it is more volatile. In contrast, a low beta fund moves less when the market fluctuates and may be relatively more stable.

Step III: Check Standard Deviation for “Consistency”

Finally, look at the standard deviation to see how relatively stable the returns are. A lower number means returns are more predictable, while a higher number means more fluctuations.

Riya is an equity investor and is comparing two funds — Fund A and Fund B. Both these schemes are benchmarked against the Nifty 50. She makes its risk and performance evaluation as follows:
 

Are you an investor with a moderate to high risk appetite? If you are looking to invest in schemes which are factor based, below are some financial products you may consider:
 

1. Alpha ETF

An Alpha ETF tries to generate higher returns (alpha) than a standard market index (like the Nifty 50). This product may capture high-performing stocks and deliver extra returns over the benchmark. However, the risks are also very high.

Some Popular Examples of Alpha ETFs are:

2. Factor-based Index Funds

These funds combine features of active + passive investing. Instead of tracking an index based only on market capitalisation, they use rule-based strategies to select stocks, such as:

• Value

• Momentum

• Volatility

• Quality
   

Again, the goal could be to beat the traditional index while keeping costs low, like a passive fund. 
 

For example, the Tata Nifty200 Alpha 30 Index Fund is an open-ended scheme replicating/tracking the Nifty200 Alpha 30 Index (TRI).  
 

The investment objective of the scheme is to provide returns, before expenses, that are commensurate with the performance of the Nifty200 Alpha 30 Index (TRI), subject to tracking error. However, there is no assurance or guarantee that the investment objective of the scheme will be achieved. The scheme does not assure or guarantee any returns.  
 

3. Factor-based ETF

A Factor-based ETF works just like a Factor-based index fund. The only difference is that it is traded on the stock exchange like a share. You can buy or sell it during market hours. 

So now you know that Alpha and Factor-based funds are those investment products that follow some type of rule-based strategy to perform.

Active Alpha based mutual funds rely on “active stock selection” by the fund manager to generate extra returns. Whereas, Factor-based funds use “rule-based strategies” to make stock selection. These strategies are usually based on factors like value, momentum, or low volatility. 

Now, as an investor, to pick the right scheme, you may evaluate both its performance + risk. This analysis can be done using three key metrics:

1. Alpha: Measures the extra return generated above the benchmark.

2. Beta: Shows the fund’s sensitivity to market movements.

3. Standard Deviation: Indicates the consistency or volatility of returns.
    

If you are looking to invest in such products, you may consider options like Alpha ETFs, Factor-based Index Funds, etc.

Disclaimer: The views mentioned above are strictly for educational purposes only. Investors must do their own research before investing.