Ratios which Investors should consider while choosing

Mutual Fund Schemes

by Mirae Asset Knowledge Academy

Investing by considering only historical returns in a mutual fund scheme is risky. Investors need to
evaluate the risk involved in mutual fund schemes before investing. There are no of ratios which
mutual fund investors should consider before making their investments. In this article we will cover
Jensen’s Alpha ratio.

Definition:
The simplest definition is the excess returns of the fund over the benchmark. Alpha is performance
ratio to measure risk-adjusted performance of a portfolio, intended to help investors determine the
risk-reward profile of a mutual fund.

Alpha measures the difference between a fund's actual returns and its expected performance, given
its level of risk. A fund's alpha is often considered to represent the value that a portfolio manager
adds to or subtracts from a fund's return above and beyond a relevant index's risk/reward profile.

Jensen's alpha was first used as a measure in the evaluation of mutual fund managers by Michael
Jensen in 1968.

Computation:
Alpha = {(Fund return-Risk free return) – (Funds beta) *(Benchmark return- risk free return)}.

Example:

Fund return 10%

Risk free return 8%
Benchmark return 5%
Beta of Fund 0.8

By computing with above formula we will get alpha as 4.4 for this fund

Significance
The Alpha as represented by percentage indicates under performance or Outperformance of a
portfolio.

o A positive alpha means the fund has outperformed its benchmark index.
Correspondingly, a negative alpha would indicate an underperformance.
o As a fund's return and its risk both contribute to its alpha, two funds with the same
returns could have different alphas.

Investors are often advised to pick funds with high Jensen Alpha ratios.
Weaknesses

o In some cases, a negative alpha can result from the expenses that are present in the fund
figures but are not present in the figures of the comparison index.

Sharpe ratios, along with Treynor ratios and Jensen's alphas, are often used to rank the
performance of portfolio or mutual fund managers.

Alpha is one of five technical risk ratios; the others are Beta, Standard Deviation, R-squared, and the
Sharpe ratio. These are all statistical measurements used in modern portfolio theory (MPT). All of
these indicators are intended to help investors determine the risk-reward profile of a mutual fund.

Mutual fund investments are subject to market risks, read all scheme related
documents carefully.