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have come as a much needed help to these investors. It is a special type of

institutional device or an investment vehicle through which the investors

pool their savings which are to be invested under the guidance of a team of

experts in wide variety of portfolios of Corporate securities in such a way,

so as to minimise risk, while ensuring safety and steady return on investment. It forms an

important part of the capital market, providing the benefits

of a diversified portfolio and expert fund management to a large number,

particularly small investors. Now a days, mutual fund is gaining its popularity due to the

following reasons :

l. With the emphasis on increase in domestic savings and improvement in

deployment of investment through markets, the need and scope for mutual

fund operation has increased tremendously. The basic purpose of reforms in the financial

sector was to enhance the generation of domesticTripathy, Mutual Fund in India: A Financial

Service in Capital . . . 87

resources by reducing the dependence on outside funds. This calls for

a market based institution which can tap the vast potential of domestic

savings and chanalise them for profitable investments. Mutual funds are

not only best suited for the purpose but also capable of meeting this

challenge.

2. An ordinary investor who applies for share in a public issue of any

company is not assured of any firm allotment. But mutual funds who

subscribe to the capital issue made by companies get firm allotment of

shares. Mutual fund latter sell these shares in the same market and to

the Promoters of the company at a much higher price. Hence, mutual

fund creates the investors confidence.

3. The phyche of the typical Indian investor has been summed up by Mr.


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S.A. Dave, Chairman of UTI, in three words; Yield, Liquidity and Security. The mutual funds,

being set up in the public sector, have given

the impression of being as safe a conduit for investment as bank deposits. Besides, the assured

returns promised by them have investors had

great appeal for the typical Indian investor.

4. As mutual funds are managed by professionals, they are considered to

have a better knowledge of market behaviours. Besides, they bring a

certain competence to their job. They also maximise gains by proper

selection and timing of investment.

5. Another important thing is that the dividends and capital gains are reinvested automaticallyin mutual funds and hence are not fritted away.

The automatic reinvestment feature of a mutual fund is a form of forced

saving and can make a big difference in the long run.

6. The mutual fund operation provides a reasonable protection to investors.

Besides, presently all Schemes of mutual funds provide tax relief under

Section 80 L of the Income Tax Act and in addition, some schemes

provide tax relief under Section 88 of the Income Tax Act lead to the

growth of importance of mutual fund in the minds of the investors.

7. As mutual funds creates awareness among urban and rural middle class

people about the benefits of investment in capital market, through profitable and safe avenues,

mutual fund could be able to make up a large

amount of the surplus funds available with these people.

8. The mutual fund attracts foreign capital flow in the country and

secure profitable investment avenues abroad for domestic savings through

the opening of off shore funds in various foreign investors. Lastly another notable thing is that

mutual funds are controlled and regulated by


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S E B I and hence are considered safe. Due to all these benefits the

importance of mutual fund has been increasing.

Schemes of Mutual Fund

Within a short span of four to five years mutual fund operation has

become an integral part of the Indian financial scene and is poised for rapid88 Finance India

growth in the near future. Today, there are eight mutual funds operating

various schemes tailored to meet the diversified needs of savers. UTI has

been able to register phenomenal growth in the mid eighties. Now there

are 121 mutual fund schemes are launched in India including UTIs scheme

attracting over Rs. 45,000 Crores from more than 3 Crore investors accounts

Out of this closed-end scheme are offered by mutual fund of India to issue

shares for a limited period which are traded like any other security as the

period and target amounts are definite under such security as the period and

target amounts are definite under such schemes. Besides open-end schemes

are lunched by mutual fund under which unlimited shares are issued by

investors but these shares are not traded by any stock exchange. However,

liquidity is provided by this scheme to the investors. In addition to this off

shore mutual funds have been launched by foreign banks, some Indian banks,

like SBI, Canara Bank etc, and UTI to facilitate movement of capital from

cash-rich countries to potentially high growth economics. Mutual funds

established by leading public sector banks since 1987-SBIMF, Can Bank, Ind

Bank, PNBMF and BOIMF, emerged since 1987-SBIMFo, as major players

by offering bond like products with assurance of higher yields. The latest

schemes of BOI mutual fund goes to the extent of allowing each individual


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investor to choose the date for receiving the income. Besides the bank

mutual funds have also floated a few open-ended schemes, pure growth

schemes and tax saving schemes. The LIC, GIC mutual funds offer insurance linked product

providing various types of life and general insurance

benefits to the investors. Also the income growth oriented schemes are

operated by mutual fund to cater to an investors needs for regular incomes

and hence, it distributes dividend at intervals.

Growth Trend of Mutual Fund

Opening of the mutual fund industry to the public sector banks and

insurance companies, led to the launching of more and more of new schemes.

The mutual fund industry in India has grown fast in the recent period. The

performance is encouraging especially because the emphasis in India has

been on individual investors rather in contrast to advanced countries where

mutual funds depend largely on institutional investors, In general, it appears

that the mutual fund in India have given a good account of themselves so far.

UTI's annual sale of units crossed Rs.1000 crores mark in 1986 to 87, 2000

crores mark in 1987-88 and reached Rs.5500 crores mark in 1989 to 90.

During 1990 to 91 on account of decline of corporate interest,, sales declined

to Rs.4100 crores though individual sales increased over its preceeding year.

LICMF has concentrated on funds which includes life and accident cover.

GICMF provide home insurance policy. The bank sponsored mutual fund

floated regular income, growth and tax incentives schemes. Together the

eight mutual fund service more than 15 million investors with UTI alone

holds for 13 million unit holding accounts. Magnum Regular Income Scheme


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1987 assured a return of 12 percent but gave 20 percent dividend in 1993,

UTI record 26 percent dividend for 1992 to 93 under the unit 1964 scheme.

Magnum Tax saving scheme 1988 to 89 did not promise any return butTripathy, Mutual Fund in

India: A Financial Service in Capital . . . 89

declared 14 percent dividend in 1993 and recorded a capital appreciation of

15 percent in the first year. Equity oriented scheme have earned attractive

returns. Especially since early 1991 there has been a steady increase in the

number of equity oriented growth funds. With the boom of June 1990 and

then again 1991 due to the implementation of new economic policies towards structure of

change the price of securities in stock market appreciated

considerably. The high rate of growth in equity price led to a high rate of

appreciation in the net asset value of the equity oriented funds for which

investors started changing their preferences from fixed income funds to growth

oriented or unfixed income funds. That is why more equity oriented mutual

funds were launched in 1991. Master share provide a respective dividend of

18 per cent in 1993, Can share earned a dividend of 15 percent in 1993. In

general the Unit Trust of India which manages over 28,000 crore under

various schemes has for its service an excellent reputation.

Short Commings in Operation of Mutual Fund

The mutual fund has been operating for the last five to six years. Thus,

it is too early to evaluate its operations. However one should not lose sight

to the fact that the formation years of any institution is very important to

evaluate as they could be able to know the good or bad systems get evolved

around this time. Following are some of the shortcomings in operation of

mutual fund.


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1. The mutual funds are externally managed. They do not have employees

of their own. Also there is no specific law to supervise the mutual funds

in India. There are multiple regulations. While UTI is governed by its

own regulations, the banks are supervised by Reserved Bank of India,

the Central Government and insurance company mutual regulations funds

are regulated by Central Government

2. At present, the investors in India prefer to invest in mutual fund as a

substitute of fixed deposits in Banks, About 75 percent of the investors

are not willing to invest in mutual funds unless there was a promise of

a minimum return,

3. Sponsorship of mutual funds has a bearing on the integrity and efficiency of fund

management which are key to establishing investor's

confidence. So far, only public sector sponsorship or ownership of

mutual fund organisations had taken care of this need.

4. Unrestrained fund rising by schemes without adequate supply of scrips

can create severe imbalance in the market and exacerbate the distortions

5. Many small companies did very well last year, by schemes without

adequate imbalance in the market but mutual funds can not reap their

benefits because they are not allowed to invest in smaller companies.

Not only this, a mutual fund is allowed to hold only a fixed maximum

percentage of shares in a particular industry.90 Finance India

6. The mutual fund in India are formed as trusts. As there is no distinction

made between sponsors, trustees and fund managers, the trustees play

the roll of fund managers.


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7. The increase in the number of mutual funds and various schemes have

increased competition. Hence it has been remarked by Senior Broker

mutual funds are too busy trying to race against each other. As a

result they lose their stabilising factor in the market.

8. While UTI publishes details of accounts their investments but mutual

funds have not published any profit and loss Account and balance sheet

even after its operation.

9. The mutual fund have eroded the financial clout of institution

in the stock market for which cross transaction between mutual funds

and financial institutions are not only allowing speculators

to manipulate price but also providing cash leading to the distortion of

balanced growth of market.

10. As the mutual fund is very poor in standard of efficiency in investors

service; such as despatch of certificates, repurchase and attending to

inquiries lead to the detoriation of interest of the investors towards

mutual fund.

11. Transparency is another area in mutual fund which was neglected till

recently. Investors have right to know and asset management companies

have an obligation to inform where and how his money has been deployed. But investors are

deprived of getting the information.

Future Outlook and Suggestion

As mutual fund has entered into the Indian Capital market, growing

profitable enough to attract competitors into this cherished territory encouraging competition

among all the mutual fund operators, there is need to

take some strategy to bring more confidence among investors for which


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mutual fund would be able to project the image successfully. The followings

are some of the suggestions. As there is no comprehensive law to regulate

the mutual fund in India, uniform coordinated regulations by a single agency

would be formed which would provide the shelter to the investors. Secondly, as the investors

are not willing to invest in mutual fund unless a

minimum return is assured, it is very essential to create in the mind of the

investors that mutual funds are market instruments and associated with market

risk hence mutual fund could not offer guaranteed income. Thirdly, all the

mutual funds are operated in the public sector. Hence private sector may be

allowed to float mutual funds, intensifying competition in this industry. Fourthly,

due to operations of many mutual fund, there will be need for appropriate

guidelines for self-regulation in respect of publicity/advertisement and interscheme

transactions within each mutual fund. Fifthly, the growth of mutual

fund tends to increase the shareholdings in good companies, give rise the

fear of destabilising among industrial group, hence introduction of non-Tripathy, Mutual Fund

in India: A Financial Service in Capital . . . 91

voting shares and lowering the debt-equity ratio help to remove these apprehension. Sixthly,

as there is no distinction between trustees, sponsors and

fund managers, it is necessary to regulate frame work for a clear demarcation

between the role of constituents, such as shelter, trustee and fund manager

to protect the interest of the small investors. Seventhly, steps should be

taken for funds to make fair and truthful disclosures of information to the

investors, so that subscribers know what risk they are taking by investing in

fund. Eighthly, infrastructure bottlenecks will have to be removed and banking and postal

systems will have to be taken place for growth of mutual

funds. Ninethly, mutual funds need to take advantage of modern technology


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like computer and tele-communications to render service to the investors.

Lastly, mutual funds are made by investors and investors interest ought to

be paramount by setting standard of behaviours and efficiency through selfregularisations and

professionalism.

Conclusion

With the structural liberalisation policies no doubt Indian economy is

likely to return to a high grow path in few years. Hence mutual fund

organisations are needed to upgrade their skills and technology. Success of

mutual fund however would bright depending upon the implementation of

suggestions.

References

1. Anagol, Malati & Katoli, Raghavendra, Mutual funds: just five year old and

ready to run at a gallop Economic Times, February 27, 1992.

2. Shukla, Sharad, Futual funds: past performance is no indicator of the future

Economic Times, June 6, 1992,

3. De, Mainak, Futual funds & institutions - paying to a different tune

Economic Times, June 15, 1991.

4. Dave, S. A., Futual Funds: Growth and Development" The Journal of

the Indian Institute of Bankers, Jan-March, 1992.

5. Bhatt, M. Narayana, Setting standards for investor services" Economic

Times, December 27, 1993.

6. State Bank of India, Monthly Review, August 1991, December 1991.

7. Marketman - Vol.1 June 1992.

8. Business India, October 15-26,, 1990,


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9. Vyas, B.A., Mutual funds - Boon to the Common Investors" Fortune

India, July 16, 1990.

10. Chandra, Prasanna, The investment Game Tata Mc.Graw-Hill publishing, New Delhi

11. Yasaswy, N.J. PersonaI Investment and Tax Planning year Book

Vision Books, New Delhi.

12. Ramola K.S., MutuaI Fund and the Indian Capital Market Yojana,

Vol. 36, No.11, June 30, 1992.

Classifying mutual funds in India: some results from clustering

Abstract

This paper attempts to classify hundred mutual funds employing cluster analysis and using a host

of criteria like the I year total return, 2 year annualized return, 3 year annualized return, 5 year

annualized return, alpha, beta, R-squared, sharpe's ratio, mean and standard deviation etc. The

data is obtained from Valuresearchonline. We do find evidences of inconsistencies between the

investment style / objective classification and the return obtained by the fund.

I. INTRODUCTION

India's mutual fund industry has grown dramatically over the last few years. In 2003-04 a sum of

Rupees 47873 crore was mobilized by mutual funds. Out of this Rupees 41510 crore was

mobilized by private sector mutual funds. One can envisage significant room for growth in the

mutual-fund business since a small fraction of the country's savings is invested in the capital

markets. Foreign money managers have also started pouring money into the mutual fund market.

In this vibrant trading atmosphere, the buyers face the challenge of diversifying their portfolio

among different types of funds. The name given to them may not always represent the style

management of the fund. The present study makes an exploratory attempt to classify hundred

mutual funds employing cluster analysis and using a host of criteria like the 1 year total return, 2

year annualized return, 3 year annualized return, 5 year annualized return, alpha, beta, R-

squared, Sharpe's ratio, mean and standard deviation etc, obtained from Valueresearchonline. We

do find evidences of inconsistencies between the investment style/objective classification and the

return obtained by the fund.

The rest of the paper is organized as the following. Section 2 traces the Indian mutual fund

industry in brief. Few past studies have been reviewed in section 3. Section 4 outlines the method


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and data sources. Results of cluster analysis are presented in section 5 and section 6 offers some

concluding remarks.

II. THE INDIAN MUTUAL FUND INDUSTRY

The mutual fund industry in India came into existence in 1963 with the establishment of Unit

Trust of India (UTI) *. Its operations began in July 1964 "with a view to encouraging savingsand investment and participation in the income, profits and gains accruing to the corporation

from the acquisition, holding, management and disposal of securities" (Sankaran, 2003, p.40).

UTI had monopoly over the fund industry until the public sector banks and insurance companies

entered the industry in 1987. Private sector mutual funds were permitted entry when the

Securities and Exchange Board of India (SEBI) formulated comprehensive regulations for the

funds. These were replaced by SEBI mutual fund regulations in 1996. Presently the mutual fund

industry comprises of the following players other than UTI.

(a) Bank sponsored

(b) Institutions

(c) Private Sector (Indian, Joint ventures-predominantly Indian, Joint venturespredominantly

foreign).

Table 2.1 presents the resources mobilized by the above players from 1990-1991 to 2004-2005.

The industry has grown in terms of size, players, and asset management. Mobilizing household

savings towards equity capital seems to be inevitable in the emerging Indian market for future

economic growth. The role of mutual fund industry assumes significance in this context.

III. SOME PAST STUDIES

Mutual funds ate usually classified on the basis of their objectives. Investors can take the

objectives as signals of their risks and incomes if the activities of mutual funds are consistent

with their stated objectives.

A study by Copen et al. (1996) investigated the manner in which consumers made investment

decisions for mutual funds. Investors reported that they considered many nonperformance related

variables. When investors were grouped by similarity of investment decision process, a single

small group appeared to be highly knowledgeable about its investments. However, most

investors appeared to be naive, having little knowledge of the investment strategies or financial

details of their investments.

JIN Xue-jun and YANG Xiao-lan (2003) analyzed mutual fund objective classification in Chinaby statistical methods of distance analysis and discriminant analysis. The authors examined if the

stated investment objectives of mutual funds adequately represented their attributes to investors.

That is, if mutual funds adhered to their stated objectives, attributes must be heterogeneous

between investment objective groups and homogeneous within them. As a whole, they found that

there existed no significant differences between different objective groups; and 50% of mutual

funds were not consistent with their objective groups.


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In the Indian context, Amanulla (2001) tested the portfolio efficiency of mutual funds of Unit

Trust of India (UTI) by employing traditional performance measures such as Jensen, Treynor and

Sharpe's methodology. Employing Granger Causality and Co-integration tests, the paper also

investigated the performance evaluation of mutual funds. Average weekly net asset values of 16

mutual funds of UTI and two stock market price indices i.e. Bombay Stock Exchange (BSE)

sensitive index as well as S & P CNX Nifty index for the period June, 1992 to July, 2000 wereused in the study. The results from traditional measures provided a mixed evidence of

performance evaluation while the evidence from Granger causality suggested the existence of

uni-directional causality in BSE sensitive index and bi-directional causality in Nifty index. The

market index and mutual funds were also found to be co-integrated, indicating a long-run

relationship.

The Association of Mutual Funds in India (AMFI) is dedicated to

developing the Indian Mutual Fund Industry on professional, healthy

and ethical lines and to enhance and maintain standards in all areas

with a view to protecting and promoting the interests of mutual

funds and their unit holders.

A STUDY ON MUTUAL FUNDS IN INDIA

INTRODUCTION

There are a lot of investment avenues available today in the financial

market for an investor with an investable surplus. He can invest in

Bank Deposits, Corporate Debentures, and Bonds where there is low

risk but low return. He may invest in Stock of companies where therisk is high and the returns are also proportionately high. The recent

trends in the Stock Market have shown that an average retailinvestor always lost with periodic bearish tends. People began

opting for portfolio managers with expertise in stock markets who

would invest on their behalf. Thus we had wealth managementservices provided by many institutions. However they proved too

costly for a small investor. These investors have found a good

shelter with the mutual funds.

Mutual fund industry has seen a lot of changes in past few years

with multinational companies coming into the country, bringing in

their professional expertise in managing funds worldwide. In the

past few months there has been a consolidation phase going on in


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the mutual fund industry in India. Now investors have a wide range

of Schemes to choose from depending on their individual profiles.

My study gives an overview of mutual funds definition, types,

benefits, risks, limitations, history of mutual funds in India, latest

trends, global scenarios. I have analyzed a few prominent mutualfunds schemes and have given my findings.

NEED FOR THE STUDY

The main purpose of doing this project was to know about mutual

fund and its functioning. This helps to know in details about mutualfund industry right from its inception stage, growth and future

prospects.

It also helps in understanding different schemes of mutual funds.

Because my study depends upon prominent funds in India and theirschemes like equity, income, balance as well as the returns

associated with those schemes.

The project study was done to ascertain the asset allocation, entry

load, exit load, associated with the mutual funds. Ultimately this

would help in understanding the benefits of mutual funds toinvestors.

SCOPE OF THE STUDYIn my project the scope is limited to some prominent mutual funds

in the mutual fund industry. I analyzed the funds depending on theirschemes like equity, income, balance. But there is so many other

schemes in mutual fund industry like specialized (banking,infrastructure, pharmacy) funds, index funds etc.

My study is mainly concentrated on equity schemes, the returns, in

income schemes the rating of CRISIL, ICRA and other credit rating

agencies.

OBJECTIVE

To give a brief idea about the benefits available from Mutual Fund

investment To give an idea of the types of schemes available.

To discuss about the market trends of Mutual Fund investment.

To study some of the mutual fund schemes and analyse them Observe the fund management process of mutual funds

Explore the recent developments in the mutual funds in India To give an idea about the regulations of mutual funds


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METHODOLOGY

To achieve the objective of studying the stock market data has beencollected.

Research methodology carried for this study can be two types

1. Primary2. Secondary

PRIMARY:

The data, which has being collected for the first time and it is the

original data.In this project the primary data has been taken from HSE staff and

guide of the project.

SECONDARY:The secondary information is mostly taken from websites, books,

journals, etc.

Limitations

The time constraint was one of the major problems.

The study is limited to the different schemes available under the

mutual funds selected. The study is limited to selected mutual fund schemes. The lack of information sources for the analysis part.

Equity Mutual Funds

Equity mutual funds are also known as stock mutual funds. Equity mutual funds investpooled amounts of money in the stocks of public companies. Stocks represent part


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ownership, or equity, in companies, and the aim of stock ownership is to see the valueof the companies increase over time. Stocks are often categorized by their marketcapitalization (or caps), and can be classified in three basic sizes: small, medium, andlarge. Many mutual funds invest primarily in companies of one of these sizes and arethus classified as large-cap, mid-cap or small-cap funds.

Equity fund managers employ different styles of stock picking when they makeinvestment decisions for their portfolios. Some fund managers use a value approach tostocks, searching for stocks that are undervalued when compared to other similarcompanies. Another approach to picking is to look primarily at growth, trying to findstocks that are growing faster than their competitors, or the market as a whole. Somemanagers buy both kinds of stocks, building a portfolio of both growth and value stocks.Since equity funds invest in stocks, they have the potential to generate more returns.On the other hand they carry greater risks too. Equity funds can be classified intodiversified equity funds and sectoral equity funds.

How to Select an Equity Fund

Compare a fund with its peers:One of the basic fundamental of benchmarking is to evaluate funds with in the samecategory. For example, if you are evaluating the performance of a thematic fund, say ITbased fund, then you should compare its performance with another similar IT basedfund. Comparing it with banking sector fund for example will not give the correct picture.Comparing a fund over stock market cycle (boom and bust) will give investors a goodidea about how the fund has fared.

Compare returns against those of the benchmark index:Every fund mentions a benchmark index in the Offer Document. It can be BSE 100,BSE 200, Nifty or any other index. The benchmark index serves as a guidepost for boththe fund manager and the investor. Compare how the fund has fared against thebenchmark index over a period of 3-5 years. The funds that have outperformed theirbenchmark indices during stock market volatility must be given a close look.

Compare against the fund's own performance:

Apart from comparing a fund with its peers and benchmark index, investors shouldevaluate its historical performance. By evaluating a fund against its own historicalperformance, you can get an idea about consistent performers.

5 Ways To Measure Mutual Fund Riskby Richard Loth (Contact Author| Biography)

Filed Under:Financial Theory, Fundamental Analysis, Mutual Funds, Statistics


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There are five main indicators of investment risk that apply to the analysis of stocks,

bonds and mutual fund portfolios. They are alpha, beta, r-squared, standard deviation

and theSharpe ratio. These statistical measures are historical predictors of investment

risk/volatility and are all major components ofmodern portfolio theory (MPT). The MPT

is a standard financial and academic methodology used for assessing the performance

of equity, fixed-income and mutual fund investments by comparing them to market

benchmarks.All of these risk measurements are intended to help investors determine

the risk-rewardparameters of their investments. In this article, we'll give a brief

explanation of each of these commonly used indicators.

1. Alpha

Alpha is a measure of an investment's performance on a risk-adjusted basis. It takes the

volatility (price risk) of a security or fund portfolio and compares its risk-adjusted

performance to a benchmark index. The excess return of the investment relative to the

return of the benchmark index is its "alpha".

Simply stated, alpha is often considered to represent the value that a portfolio manager

adds or subtracts from a fund portfolio's return. A positive alpha of 1.0 means the fund

has outperformed its benchmark index by 1%. Correspondingly, a similar negative alpha

would indicate an underperformance of 1%. For investors, the more positive an alpha is,

the better it is. (To learn more, seeAdding Alpha Without Adding Risk.)

2. Beta

Beta, also known as the "beta coefficient," is a measure of the volatility, orsystematic

risk, of a security or a portfolio in comparison to the market as a whole. Beta iscalculated using regression analysis, and you can think of it as the tendency of an

investment's return to respond to swings in the market. By definition, the market has a

beta of 1.0. Individual security and portfolio values are measured according to how they

deviate from the market.

A beta of 1.0 indicates that the investment's price will move in lock-step with the market.

A beta of less than 1.0 indicates that the investment will be less volatile than the market,

and, correspondingly, a beta of more than 1.0 indicates that the investment's price will

be more volatile than the market. For example, if a fund portfolio's beta is 1.2, it's

theoretically 20% more volatile than the market.

Conservative investors looking to preserve capital should focus on securities and fund

portfolios with low betas, whereas those investors willing to take on more risk in search

of higher returns should look for high beta investments. (Keep reading about beta

in Beta: Know the Risk.)


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3. R-Squared

R-Squared is a statistical measure that represents the percentage of a fund portfolio's or

security's movements that can be explained by movements in a benchmark index. For

fixed-income securities and their corresponding mutual funds, the benchmark is

the U.S. Treasury Bill and, likewise with equities and equity funds, the benchmark is

the S&P 500 Index.

R-squared values range from 0 to 100. According to Morningstar, a mutual fund with an

R-squared value between 85 and 100 has a performance record that is closely

correlated to the index. A fund rated 70 or less would not perform like the index.

Mutual fund investors should avoid actively managed funds with high R-squared ratios,

which are generally criticized by analysts as being "closet" index funds. In these cases,

why pay the higher fees for so-called professional management when you can get thesame or better results from an index fund? (To learn more, read Understanding Volatility

Measurements, The Lowdown On Index Funds and Benchmark Your Returns With

Indexes.)

4. Standard Deviation

Standard deviation measures the dispersion of data from its mean. In plain English, the

more that data is spread apart, the higher the difference is from the norm. In finance,

standard deviation is applied to the annual rate of return of an investment to measure its

volatility (risk). A volatile stock would have a high standard deviation. With mutual funds,

the standard deviation tells us how much the return on a fund is deviating from theexpected returns based on its historical performance.

5. Sharpe Ratio

Developed by Nobel laureate economist William Sharpe, this ratio measures risk-

adjusted performance. It is calculated by subtracting the risk-free rate of return (U.S.

Treasury Bond) from the rate of return for an investment and dividing the result by the

investment's standard deviation of its return.

The Sharpe ratio tells investors whether an investment's returns are due to smart

investment decisions or the result of excess risk. This measurement is very useful

because although one portfolio or security can reap higher returns than its peers, it is

only a good investment if those higher returns do not come with too much additional

risk. The greater an investment's Sharpe ratio, the better its risk-adjusted

performance. (Keep reading about this subject inUnderstanding The Sharpe

Ratio and The Sharpe Ratio Can Oversimplify Risk.)


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Conclusion

Many investors tend to focus exclusively on investment return, with little concern for

investment risk. The five risk measures we have just discussed can provide some

balance to the risk-return equation. The good news for investors is that these indicators

are calculated for them and are available on several financial websites, as well as being

incorporated into many investment research reports. As useful as these measurements

are, keep in mind that when considering a stock, bond, or mutual fund investment,

volatility risk is just one of the factors you should be considering that can affect the

quality of an investment.

For more insight, read Understanding Volatility Measurements.

by Richard Loth (Contact Author| Biography)

Richard Loth has more than 38 years of professional experience in the financial

services sector, including banking, investment consulting and capital marketsdevelopment, both internationally and in the U.S. He has worked with Citibank, FleetNationalBank and the Bank of Montreal. Mr. Loth is currently the managing principal ofMentor Investing, an independent Registered Investment Adviser based in Eagle,Colorado. Over the years, he has authored several investment education articles,

publications, and books.

Sharpe ratio

The Sharpe ratio orSharpe index orSharpe measure orreward-to-variability

ratio is a measure of the excess return (orrisk premium) per unit of risk in an

investment asset or a trading strategy, named afterWilliam Forsyth Sharpe. Since its

revision by the original author in 1994, it is defined as:

where R is the asset return, Rfis the return on a benchmark asset, such as the risk

free rate of return, E[R Rf] is the expected value of the excess of the asset return

over the benchmark return, and is the standard deviation of the excess of the

asset return (this is often confused with the excess return over the benchmarkreturn; the Sharpe ratio utilizes the asset standard deviation whereas the

information ratio utilizes standard deviation of excess return over the benchmark,

i.e. the tracking error, as the denominator.). Note, ifRfis a constant risk free return

throughout the period,


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The Sharpe ratio is used to characterize how well the return of an asset

compensates the investor for the risk taken, the higher the Sharpe ratio

number the better. When comparing two assets each with the expected

return E[R] against the same benchmark with return Rf, the asset with the

higher Sharpe ratio gives more return for the same risk. Investors are often

advised to pick investments with high Sharpe ratios. However like any

mathematical model it relies on the data being correct. Pyramid schemes with

a long duration of operation would typically provide a high Sharpe ratio when

derived from reported returns but the inputs are false. When examining the

investment performance of assets with smoothing of returns (such as with-

profits funds) the Sharpe ratio should be derived from the performance of the

underlying assets rather than the fund returns.

Sharpe ratios, along with Treynor ratios and Jensen's alphas, are often used torank the performance of portfolio ormutual fund managers.

Strengths and weaknesses

The Sharpe ratio has as its principal advantage that it is directly computable from any

observed series of returns without need for additional information surrounding the

source of profitability. Other ratios such as the bias ratio have recently been introduced

into the literature to handle cases where the observed volatility may be an especially

poor proxy for the risk inherent in a time-series of observed returns.

While the Treynor ratio works only with systematic risk of a portfolio, the Sharpe ratio

observes both systematic and idiosyncratic risks.

The returns measured can be of any frequency (i.e. daily, weekly, monthly or annually),

as long as they are normally distributed, as the returns can always be annualized.

Herein lies the underlying weakness of the ratio - not all asset returns are normally

distributed. Abnormalities like kurtosis, fatter tails and higher peaks, orskewness on

the distribution can be a problematic for the ratio, as standard deviation doesn't have

the same effectiveness when these problems exist. Sometimes it can be downright

dangerous to use this formula when returns are not normally distributed. [4]

Because it is a dimensionless ratio, laypeople find it difficult to interpret Sharpe Ratios

of different investments. For example, how much better is an investment with a Sharpe

Ratio of 0.5 than one with a Sharpe Ratio of -0.2? This weakness was well addressed


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by the development of the Modigliani Risk-Adjusted Performance measure, which is in

units of percent return -- universally understandable by virtually all investors.

Treynor ratio

The Treynor ratio (sometimes called the reward-to-volatility ratio orTreynor

measure[1]), named afterJack L. Treynor,[2] is a measurement of the returns earned in

excess of that which could have been earned on an investment that has no diversifiable

risk (e.g., Treasury Bills or a completely diversified portfolio), per each unit of market

risk assumed.

The Treynor ratio relates excess return over the risk-free rate to the additional risk

taken; however, systematic risk is used instead of total risk. The higher the Treynor

ratio, the better the performance of the portfolio under analysis.

Formula

where:

Treynor ratio,

portfolio i's return,

risk free rate

portfolio i's beta

[edit]Limitations

Like the Sharpe ratio, the Treynor ratio (T) does not quantify the

value added, if any, of active portfolio management. It is a

ranking criterion only. A ranking of portfolios based on the

TreynorRatio is only useful if the portfolios under consideration

are sub-portfolios of a broader, fully diversified portfolio. If this is

not the case, portfolios with identical systematic risk, but different

total risk, will be rated the same. But the portfolio with a higher

total risk is less diversified and therefore has a higherunsystematic risk which is not priced in the market.

An alternative method of ranking portfolio management

is Jensen's alpha, which quantifies the added return as the

excess return above the security market line in the capital asset

pricing model. As these two methods both determine rankings


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based on systematic risk alone, they will rank portfolios

identically.

International Research Journal of Finance and Economics

ISSN 1450-2887 Issue 30 (2009)

EuroJournals Publishing, Inc. 2009

http://www.eurojournals.com/finance.htm

Generalized Sharpe Ratios: Performance Measures Focusing on

Downside Risk

George J. Jiang

Department of Finance, Eller College of Management

University of Arizona Tucson,Arizona 85721-0108

Yunan University of Finance and Economics, Kunming, China

E-mail: [email protected]

Tel: +1-520-6213373; Fax: +1-520-6211261

Kevin X. Zhu

Ibbotson Associates/Morningstar, 22 W. Washington, Chicago, IL 60602

E-mail: [email protected]

Tel: +1-312-6966823; Fax: +1-312-6966701

Abstract

In this paper, we construct a new measure of fund performance by combining two

commonly used measures, namely, the Sharpe ratio and the second-degree stochastic

dominance (SSD). For a given fund, we use the SSD criteria to identify an equivalent fund

with normal return distribution. The Sharpe ratio of the equivalent fund is referred to as the

generalized Sharpe ratio (GSR). The generalized Sharpe ratio not only provides a complete

rank of funds but also is consistent with investors risk aversion. We show that the


25/37

generalized Sharpe ratio has an intuitively appealing link to various moments of the fund

return distribution. In addition, we extend the generalized Sharpe ratio to the left tails of

fund return distribution to measure the downside risk of a fund. Applying to a sample of

mutual funds, our results show that the ranking based on the new measure can be

substantially different from that based on the conventional Sharpe ratio, with our measure

directly tying to the distKeywords: Sharpe Ratio, Stochastic Dominance, Portfolio Performance

JEL Classification Codes: G11, G12, C14

1. Introduction

How to measure the performance of mutual funds is an important issue to both academics and

practitioners. At the end of each year, mutual funds are ranked by various news media and

financial

research agencies, such as newspapers, investment banks and financial advisors. Such

published

ranking has a profound impact on the compensation of fund managers, the reallocation of fund

portfolio, as well as individual investors fund choice and investment decisions.

There are mainly two groups of fund performance measures developed in the existing

literature.

In the first group of literature, specific asset pricing models are used as a benchmark for fund

performance. The basic idea is to adjust risk premium associated with various systematic

factors and to

gauge the expected fund return. For instance, the commonly-used Jensens alpha, Treynors

measure,

and Appraisal ratio, are all based on the capital asset pricing model (CAPM) or the market

model.ributional features of fund returns.

Understanding The Sharpe Ratio


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ince the Sharpe ratio was derived in 1966 by William Sharpe, it has been one of the

most referenced risk/return measures used in finance, and much of this popularity can

be attributed to its simplicity. The ratio's credibility was boosted further when Professor

Sharpe won a Nobel Memorial Prize in Economic Sciences in 1990 for his work on

the capital asset pricing model (CAPM). In this article, we'll show you how this historic

thinker can help bring you profits. (To find out more on this subject, see The Capital

Asset Pricing Model: An The Ratio Defined

Most people with a financial background can quickly comprehend how the Sharpe ratio

is calculated and what it represents. The ratio describes how much excess return you

are receiving for the extra volatility that you endure for holding a riskier asset.

Remember, you always need to be properly compensated for the additional risk you

take for not holding arisk-free asset.

We will give you a better understanding of how this ratio works, starting with its formula:

OverviUsing the Sharpe Ratio

The Sharpe ratio is a risk-adjusted measure of return that is often used to evaluate the

performance of a portfolio. The ratio helps to make the performance of one portfolio

comparable to that of another portfolio by making an adjustment for risk.

For example, if manager A generates a return of 15% while manager B generates a

return of 12%, it would appear that manager A is a better performer. However, if

manager A, who produced the 15% return, took much larger risks than manager B, it

may actually be the case that manager B has a better risk-adjusted return.

To continue with the example, say that the risk free-rate is 5%, and manager A's

portfolio has a standard deviation of 8%, while manager B's portfolio has a standard

deviation of 5%. The Sharpe ratio for manager A would be 1.25 while manager B's ratio

would be 1.4, which is better than manager A. Based on these calculations, manager B

was able to generate a higher return on a risk-adjusted basis.


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To give you some insight, a ratio of 1 or better is considered good, 2 and better is very

good, and 3 and better is considered excellent.

Conclusion

The Sharpe ratio is quite simple, which lends to its popularity. It's broken down into just

three components: asset return, risk-free return and standard deviation of return. After

calculating the excess return, it's divided by the standard deviation of the risky asset to

get its Sharpe ratio. The idea of the ratio is to see how much additional return you are

receiving for the additional volatility of holding the risky asset over a risk-free asset - the

higher the better.ewand The Sharpe Ratio Can Oversimplify Risk.)

Sharpe ratio for judging MF's performance

There are various measurements that are used for the evaluation of themutual fund schemes present in the portfolio of the investor. Some of the

routes used are quite simple that involve just calculation of returns, which

do not require much efforts or working.

On the other side, there are also other options that enable a person to see

deeper within the investment and get additional insights. This calls for some

additional calculations and one of the ways in which this is done is through

the use of the Sharpe ratio.

Sharpe ratio

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It is not enough that the investor should know just

the absolute returns that are available from a

particular investment. What is important is to

understand the risk that is taken in the process of

earning this kind of returns. This is vital so that the

investor knows how the particular return is being

generated.

Some people would be happy with a lower return if

they know that there is a lower risk that is present

for them while others would not be averse to taking

high risks in their efforts to get to higher returns.

Analysis of top funds

The Sharpe ratio shows the risk return relationship and is calculated as the

return of the portfolio or the mutual fund scheme less the return of risk free

assets divided by the standard deviation of the scheme. The numerator

calculates the extra returns that are generated by the scheme as compared

with risk free returns while in the denominator the standard deviation looks

at the risk element in the entire process.

Knowing the calculation is just one part of the entire process because what

is more important for the investor is to actually understand what the figures

actually mean for their investment.

Fund management style has implications for investors

Understanding calculations

The Sharpe ratio can be used by the investor to understand the details

behind the performance of a mutual fund scheme. Just looking at the returns

might not give a complete picture to the investor and hence they need to

consider other indicators like this in the evaluation process.

Consider a scheme that has generated a 20 per cent return while the risk

free rate of return is 8 per cent. The standard deviation of this scheme is

calculated at 12 and hence if the Sharpe ratio is calculated then this comes

to (20-8)/12 which comes to 1. In this case it can be seen that while the

scheme has managed a return of 20 per cent there was some volatility in the

form of the standard deviation figure that has been witnessed.

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How MF investors can avoid entry load

There is another scheme which has managed a return of just 16 per cent but

this has a low standard deviation in the form of 6 which is half that of the

previous scheme. In this case if the Sharpe ration calculation is dome then

the ratio comes to (16-8)/6 it is 1.33. In this case there is a higher ratio

even though the return is lower than the first scheme.

Implications

A higher Sharpe ratio means a better position for the investor because this

shows that the investor is earning a higher amount for taking a particular

amount of risk. That is the meaning of the Sharpe ratio calculations. A

higher figure puts the investor in a better position and hence they will find

that this is beneficial for their overall investments.

Factor resulting in gains for debt funds

The situation could turn out to be different for the investor if they consider

this factor as compared to the other indicators that are usually seen. If just

the returns figure is considered then there can be several investments that

might look better.

However, the results can be different once the Sharpe ratio is brought into

play. In the example above the first investment has a higher return in

absolute terms but the moment there is a look at the Sharpe ratio for the

purpose of the decision then the second scheme is better.

Different people can look at the Sharpe ratio in various ways and use it

accordingly and hence there is an element of attuning it to the requirements

of the individual.

Thus there might be a person who is very happy with taking a higher risk

but the primary concern for such an investor is returns so in this case high

Sharpe ratio schemes will be selected which will also have a higher standard

deviation. But this can work both ways, as even the losses can be high.

Then there can be an investor who would want a lower volatility but still

generate adequate returns for the risk taken. In such a situation a scheme

that has a lower standard deviation but a relatively higher Sharpe ratio can

be consider for investment. There are several such variations that can be

used by the investor to achieve their objectives.


30/37

Jensen's Measure

What Does Jensen's Measure Mean?A risk-adjusted performance measure that represents the average return on a portfolio

over and above that predicted by the capital asset pricing model (CAPM), given theportfolio's beta and the average market return. This is the portfolio's alpha. In fact, theconcept is sometimes referred to as "Jensen's alpha."

ensen's alpha

From Wikipedia, the free encyclopedia

In finance, Jensen's alpha[1] (orJensen's Performance Index, ex-post alpha) is

used to determine the abnormal return of a security orportfolio of securities over the

theoretical expected return.

The security could be any asset, such as stocks, bonds, or derivatives. The theoretical

return is predicted by a market model, most commonly the Capital Asset Pricing

Model (CAPM) model. The market model uses statistical methods to predict the

appropriate risk-adjusted return of an asset. The CAPM for instance uses beta as a

multiplier.

Jensen's alpha was first used as a measure in the evaluation ofmutual fund managers

by Michael Jensen in 1968. The CAPM return is supposed to be 'risk adjusted', which

means it takes account of the relative riskiness of the asset. After all, riskier assets will

have higher expected returns than less risky assets. If an asset's return is even higher

than the risk adjusted return, that asset is said to have "positive alpha" or "abnormal

returns". Investors are constantly seeking investments that have higher alpha.

In the context of CAPM, calculating alpha requires the following inputs:

the realized return (on the portfolio),

the market return,

the risk-free rate of return, and


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the beta of the portfolio.

Jensen's alpha = Portfolio Return [Risk Free Rate + Portfolio Beta * (Market

Return Risk Free Rate)]

Since Eugene Fama, many academics believe financial markets are too efficient to

allow for repeatedly earning positive Alpha, unless by chance. To the contrary,

empirical studies of mutual funds spearheaded by Russ Wermers usually confirm

managers' stock-picking talent, finding positive Alpha. However, they also show

that after fees and expenses are deducted, the effective Alpha for investors is

negative. (These results also explain why passive investing is increasingly

popular.[citation needed])

Nevertheless, Alpha is still widely used to evaluate mutual fund and portfoliomanager performance, often in conjunction with the Sharpe ratio and the Treynor

ratio.

[edit]Use in Quantitative Finance[2]

Jensen's alpha is a statistic that is commonly used in empirical finance to assess

the marginal return associated with unit exposure to a given strategy. Generalizing

the above definition to the multifactor setting, Jensen's alpha is a measure of the

marginal return associated with an additional strategy that is not explained by

existing factors.

We obtain the CAPM alpha if we consider excess market returns as the only factor.

If we add in the Fama-French factors, we obtain the 3-factor alpha, and so on. If

Jensen's alpha is significant and positive, then the strategy being considered has a

history of generating returns on top of what would be expected based on other

factors alone. For example, in the 3-factor case, we may regress momentum factor

returns on 3-factor returns to find that momentum generates a significant premium

on top of size, value, and market returns.

Performance Measures OfMutual Funds

Mutual Fund industry today, with about 34 players and more than five hundredschemes, is one of the most preferred investment avenues in India. However, with a

plethora of schemes to choose from, the retail investor faces problems in selectingfunds. Factors such as investment strategy and management style are qualitative, but

the funds record is an important indicator too. Though past performance alone can notbe indicative of future performance, it is, frankly, the only quantitative way to judge


32/37

how good a fund is at present. Therefore, there is a need to correctly assess the pastperformance of different mutual funds.

Worldwide, good mutual fund companies over are known by their AMCs and this fame

is directly linked to their superior stock selection skills. For mutual funds to grow,

AMCs must be held accountable for their selection of stocks. In other words, theremust be some performance indicator that will reveal the quality of stock selection ofvarious AMCs.

Return alone should not be considered as the basis of measurement of the performance

of a mutual fund scheme, it should also include the risk taken by the fund managerbecause different funds will have different levels of risk attached to them. Risk

associated with a fund, in a general, can be defined as variability or fluctuations in thereturns generated by it. The higher the fluctuations in the returns of a fund during a

given period, higher will be the risk associated with it. These fluctuations in the returnsgenerated by a fund are resultant of two guiding forces. First, general market

fluctuations, which affect all the securities present in the market, called market risk orsystematic risk and second, fluctuations due to specific securities present in the

portfolio of the fund, called unsystematic risk. The Total Riskof a given fund is sumof these two and is measured in terms ofstandarddeviation of returns of the fund.

Systematic risk, on the other hand, is measured in terms ofBeta, which representsfluctuations in the NAV of the fund vis--vis market. The more responsive the NAV

of a mutual fund is to the changes in the market; higher will be its beta. Beta iscalculated by relating the returns on a mutual fund with the returns in the market.

While unsystematic risk can be diversified through investments in a number ofinstruments, systematic risk can not. By using the risk return relationship, we try to

assess the competitive strength of the mutual funds vis--vis one another in a betterway.

In order to determine the risk-adjusted returns of investment portfolios, several eminentauthors have worked since 1960s to develop composite performance indices to evaluate

a portfolio by comparing alternative portfolios within a particular risk class. The mostimportant and widely used measures of performance are:

The Treynor Measure

The Sharpe Measure

Jenson Model

Fama Model

TheTreynor Measure

Developed by Jack Treynor, this performance measure evaluates funds on the basis of


33/37

Treynor's Index. This Index is a ratio of return generated by the fund over and aboverisk free rate of return (generally taken to be the return on securities backed by the

government, as there is no credit risk associated), during a given period and systematicrisk associated with it (beta). Symbolically, it can be represented as:

Treynor's Index (T

i) = (Ri - Rf)/Bi.

Where, Ri represents return on fund, Rfis risk free rate of return and Biis beta of thefund.

All risk-averse investors would like to maximize this value. While a high and positive

Treynor's Index shows a superior risk-adjusted performance of a fund, a low andnegative Treynor's Index is an indication of unfavorable performance.

The Sharpe Measure

In this model, performance of a fund is evaluated on the basis of Sharpe Ratio, which isa ratio of returns generated by the fund over and above risk free rate of return and thetotal risk associated with it. According to Sharpe, it is the total risk of the fund that the

investors are concerned about. So, the model evaluates funds on the basis of reward perunit of total risk. Symbolically, it can be written as:

Sharpe Index (Si) = (Ri - Rf)/Si

Where, Si is standard deviation of the fund.

While a high and positive Sharpe Ratio shows a superior risk-adjusted performance of

a fund, a low and negative Sharpe Ratio is an indication of unfavorable performance.

ComparisonofSharpeandTreynor

Sharpe and Treynor measures are similar in a way, since they both divide the riskpremium by a numerical risk measure. The total risk is appropriate when we are

evaluating the risk return relationship for well-diversified portfolios. On the other hand,the systematic risk is the relevant measure of risk when we are evaluating less than

fully diversified portfolios or individual stocks. For a well-diversified portfolio thetotal risk is equal to systematic risk. Rankings based on total risk (Sharpe measure) and

systematic risk (Treynor measure) should be identical for a well-diversified portfolio,

as the total risk is reduced to systematic risk. Therefore, a poorly diversified fund thatranks higher on Treynor measure, compared with another fund that is highlydiversified, will rank lower on Sharpe Measure.

Jenson Model

Jenson's model proposes another risk adjusted performance measure. This measure wasdeveloped by Michael Jenson and is sometimes referred to as the Differential Return


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Method. This measure involves evaluation of the returns that the fund has generated vs.the returns actually expected out of the fund given the level of its systematic risk. The

surplus between the two returns is called Alpha, which measures the performance of afund compared with the actual returns over the period. Required return of a fund at a

given level of risk (Bi) can be calculated as:

Ri = Rf+ Bi (Rm - Rf)

Where, Rm is average market return during the given period. After calculating it, alphacan be obtained by subtracting required return from the actual return of the fund.

Higher alpha represents superior performance of the fund and vice versa. Limitation ofthis model is that it considers only systematic risk not the entire risk associated with the

fund and an ordinary investor can not mitigate unsystematic risk, as his knowledge ofmarket is primitive.

Fama Model

The Eugene Fama model is an extension of Jenson model. This model compares the

performance, measured in terms of returns, of a fund with the required returncommensurate with the total risk associated with it. The difference between these two

is taken as a measure of the performance of the fund and is called net selectivity.

The net selectivity represents the stock selection skill of the fund manager, as it is the

excess return over and above the return required to compensate for the total risk takenby the fund manager. Higher value of which indicates that fund manager has earned

returns well above the return commensurate with the level of risk taken by him.

Required return can be calculated as: Ri = Rf+ Si/Sm*(Rm - Rf)

Where, Sm is standard deviation of market returns. The net selectivity is thencalculated by subtracting this required return from the actual return of the fund.

Among the above performance measures, two models namely, Treynor measure andJenson model use systematic risk based on the premise that the unsystematic risk is

diversifiable. These models are suitable for large investors like institutional investorswith high risk taking capacities as they do not face paucity of funds and can invest in a

number of options to dilute some risks. For them, a portfolio can be spread across a

number of stocks and sectors. However, Sharpe measure and Fama model that considerthe entire risk associated with fund are suitable for small investors, as the ordinaryinvestor lacks the necessary skill and resources to diversified. Moreover, the selection

of the fund on the basis of superior stock selection ability of the fund manager will alsohelp in safeguarding the money invested to a great extent. The investment in funds that

have generated big returns at higher levels of risks leaves the money all the more proneto risks of all kinds that may exceed the individual investors' risk appetite.


35/37

Source: Mutualfundsindia Research Team

Why Invest in Mutual Funds

What are the benefits of mutual funds?

Role of funds in a consumer's portfolio

What are the benefits ofmutual funds?

y Convenience: Investors who have the time and the money can build their

portfolio by buying one security at a time. But identifying, researching and

monitoring securities can be a full-time job that requires a lot of commitment.

Alternatively, investors can simply buy a mutual fund in the market that will save

them a lot of time and regular monitoring of the performance of the individual

securities that make up the fund.

y Diversification: A single fund can hold securities from 100s of different issuers

or companies, far more than what an individual investor can realistically manage

to hold in their individual portfolios. This diversification reduces the risk of a loss

due to problems in one particular company or industry.

y Professional management: A mutual fund is managed by professional investors

who do this full time. The resources available to them like traders who have

practical experience in when to buy and sell securities, research team and

access to company management is far more than what an individual investors

can achieve on his own.

y Liquidity: Like shares, mutual funds are also liquid investments that can be

bought or sold freely so that investors have access to their money when needed.

However, certain shares might not trade freely because there is not market for

them, and then the investor is stuck. Mutual funds do not face this problem of

illiquidity.

TopRole of funds in a consumer's portfolio

y Growth and Inflation Hedge: Traditional savings instruments cannot keep pace

with inflation and the rising cost of living. They give only 3.5% in a savings


36/37

accounts. You can use a mixture of mutual funds to achieve a better return than

what you can get in a savings account

y Source ofIncome: Can provide you with income if you invest in an income or

dividend paying fund, along with giving you a modest capital appreciation

y How does it differ from Life Insurance Savings Product: A mutual fund is a

capital market investment product that gives you a return based on the amount of

risk taken by you.

Life insurance on the other hand is not an insurance product, but rather a

protection product that will compensate your family or survivors in case

something happens to you.

There are some types of life insurance that have an investment feature attached

to them. Please understand that such type of hybrids can be recreated by you bysimply combining a pure life insurance product along with a mutual fund. And,

you will pay lesser in fees if you do this on your own, because these hybrids have

much higher fees.

These hybrids have a purpose in your portfolio if you are looking for some capital

appreciation along with life/risk cover. Ultimately, you need to decide what your

needs are and whether the product you are looking at meets your needs or not.

The Sharpe RatioHas Its Limitations

Despite these weaknesses, the Sharpe ratio is the principal instrument used by

investment analysts to measure risk-adjusted returns. It presents a more complete

picture of fund performance than raw return, and can help investors to evaluate the

relative success of competing funds following the same broad investment strategies.

Perhaps like all statistics, it can be remarkably useful, but only if its limitations are

recognized.


37/37

Ratios To Evaluate Mutual Funds Performance

Definition of the parameters for evaluation: Sharpe Ratio: It is calculated by

subtracting the risk-free rate of return (return on government securities) from the rateof return for a portfolio and dividing the result by the standard deviation of the portfolio

returns. {draw:line} {draw:frame} {draw:frame} Sharpe Ratio = Where rp = Expected

portfolio rate of return rf = Risk free rate of return p = Portfolio standard deviation

Since standard deviation is a measure of the associated risk (systematic + unsystematic)

of a portfolio, it helps to evaluate whether the portfolio's returns are due to smart

investment decisions or a result of excess risk. Thus, the greater the Sharpe ratio of a

portfolio better has been its risk-adjusted performance. {draw:frame} {draw:frame}

{draw:line} Treynor Ratio: it measures returns earned in excess of that which could

have been earned on a risk-less investment per each unit of market risk. Treynor Ratio

= Where rp = Expected portfolio rate of return rf = Risk free rate of return = beta ofthe portfolio Thus, the Treynor ratio is a risk-adjusted measure of return based on

systematic risk. The difference between the Sharpe ratio and the Treynor ratio is the use

of beta instead of standard deviation as the measurement of risk / volatility. Point to

Remember: A completely or totally diversified portfolio of securities is the one which

reduces its unsystematic risk (diversifiable risk) to zero. Thus, for a totally diversified

portfolio, the total risk associated with the portfolio is just the systematic risk or the

undiversified risk. Total risk of diversified portfolio = Systematic Risk ( Beta)

Therefore for well diversified portfolio, Sharpe Ratio will be equal to the Treynor ratio.

Fama: It measures the return given by the fund and the required returns to

commensurate the risk associated with it. The difference between the returns is calledNet Selectivity and is a measure of the performance of the fund and the...

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