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Performance Measurement of Mutual Fund Schemes

1. Change in NAV
Example
Funds NAV at the beginning = Rs. 20
NAV at the end = Rs. 22
Then absolute change is Rs. 2 (i.e. 22-20).
Change in % terms = 2 / 20 x 100 = 10%

2. Total Return
Example
Let us assume that an investor purchased 1 unit of an open end fund at Rs. 20. The
fund had an interim dividend distribution of Rs. 4 per unit. Assume NAV at the end of
the year was Rs. 22. Then the total return will be
4 + 4 / 20 x 100 = 30%

3. Return on Investment or Total Return with dividend reinvested at NAV


Example
Assume that an investor purchased 1 unit of an open end equity fund at Rs. 20. The fund
had an interim dividend distribution of Rs. 4 per unit, when the NAV was Rs. 21.
The distribution of Rs. 4 was reinvested in the fund at Rs. 21 per unit, giving the investor
0.19 unit (i.e. 4 / 21) in the fund, making his total holding 1.19 (original 1 unit + 0.19
through reinvestment).
Now let us assume that the NAV of the fund at year end was Rs. 22.
The value of the investors holding at the end is Rs. 26.18 (i.e. 22 x 1.19), giving the
investor a Total Return with reinvestment of distribution of 30.9% (i.e. 26.18 20 / 20).
Note that this is higher than the simple Total Return of 30% computed in the previous
section.

4. Standard Deviation
It quantifies the degree to which returns fluctuate around their average. A higher value of
standard deviation means higher risk. Though SD measures volatility on both the upside
and the downside, its a good proxy for measuring the risk of loss with any security. In
real world, the larger the swings in a securitys return the more likely it is to dip into
negative territory.
Example
A
Monthly Returns
0.01
0.09
0.08
0.08
0.10
0.09

1
2
3
4
5
6

The STD is 0.0327


Annualised SD = 0.0327 * square root of 12 = 11.33%
Standard deviation is interpreted as follows:
The fund has a monthly standard deviation of 3.27%. Suppose the monthly return of the
scheme is 2%. This means in future:
-

there is 66.7% probability that the fund return would be


between 2% -3.27% to 2% + 3.27%

there is 95% probability that the fund return would be


between 2% - 6.54% to 2% + 6.54%.
there is 99% probability that the fund return would be
between 2% - 9.81% to 2% + 9.81%.

5. Beta
Market risk is measured by Beta..
Example
2

If stock A has a beta of 1.2 and stock B has a beta of 1.1 and they make up the portfolio
in the ratio of 60 : 40, the Beta of the portfolio will be
Bp = 0.60 * 1.2 + 0.40 * 1.1 = 1.16.
Beta is fairly easy to interpret. A beta that is greater than one means that the fund or
stock is more volatile than the benchmark index, while a beta of less than one means that
the security is less volatile than the index.
If the market goes up by 10%, a fund with a beta of 1.0 should go up 10%, too, while if
the market drops 10%, the fund should drop by an equal amount.
If a fund with a beta of 1.1 would be expected to be a bit more volatile than the market: If the market gains 10% our fund should on average gain 11%, while a 10% drop in the
market should result in an 11% drop by the fund.
A fund with a beta of 0.9 would return 9% when the market went up 10%, but would
lose only 9% when the market dropped by 10%.
6. Sharpe Ratio
Example
After applying the formula, we get a value of 0.8604.
This suggests that the fund has generated 0.86 percentage point of return above the risk
free return for each percentage point of standard deviation.
A fund with a higher Sharpe ratio in relation to another is preferable as it indicates that
the fund has higher risk premium for every unit of standard deviation risk.

7. Tracking Error
Performance of an index fund be it debt or equity is measured by computing tracking
error (TE). TE is a statistic that indicates the divergence of the return of the fund from

the index. It is calculated on the basis of past data and is usually taken as indicator of
future performance.
TE is calculated as follows:
-

Daily returns are calculated for the fund

(NAV (t) NAV (t-1)) / NAV (t-1).


-

Daily returns on the index is calculated

Difference between the fund return and index return is obtained

Standard deviation of the difference is calculated.

The result is the TE on a per day basis. To convert it into annual basis this is multiplied
by square root of 252 (being the number of trading days in a calendar year).
TE annualized = TE daily * SQRT (252)
Annualised TE is the standard measure of performance of an index fund.
TE is interpreted as follows:
Say a fund TE = 0.5%. This means in future,
-

there is 66.7% probability that the fund return would be between


RI - 0.5% and RI +0.5%.

there is 95% probability that the fund return would be between


RI - 1% and RI + 1%.

there is 99% probability that the fund return would be between


RI 1.5% and RI + 1.5%
Where RI is the return from the underlying index.

The reasons for the existence TE is the divergence of fund portfolio from the
underlying index and the presence of transaction costs. Even if the fund portfolio
exactly maps the underlying index, it should be noted that the theoretical benchmark
does not have to bear the transaction costs.