Recent fall in the stock markets and sudden down fall in the mutual funds returns, many of the investors are coming to their financial advisors asking about the best mutual funds in volatile markets. This has resulted into attention to the alpha and beta values of the mutual fund. Mutual fund advisors or financial planners are always focussing on these two values while advising to their clients.
Alpha and beta are the two individual quantitative variables that are being used to analyse a particular stock, asset, mutual fund to gauge its performance over its peers in order to generate better returns amongst the set of stocks under analysis. The value derived after mathematical calculations of means, index, total etc. for a certain group of stocks under evaluation. However, retail investors or individuals don’t have much idea about these calculations or meaning of alpha and beta values. This article comprises of explanation in simple and understandable language for these values.
What is alpha α?
Last year SEBI has made mandatory for all the asset management companies to keep a single mutual fund in every category to make investors comfortable for selection of scheme as per their risk appetite. Alpha value helps for selection of perfectly suitable scheme for investment. Every mutual fund is corresponding index which is set as a corresponding benchmark to evaluate the funds’ performance. For example, for any mutual fund which is under large cap category may have its corresponding index as NIFTY 50.
Now let us understand about what is alpha value in mutual fund ? Let us take two large cap schemes Scheme A and Scheme B having the same benchmark index for the time consider Nifty Fifty Index. Now let us consider that Scheme A has given return of 15 % and Scheme B given return of 10 % and both of its benchmark that is Nifty Fifty Index has given a return of 10%. So here we can say Scheme A has delivered the return 5% more compared to its benchmark and this excess return is the alpha of the Scheme A for the particular time under consideration. Therefore, Value of Alpha of any mutual fund scheme states that it can generate that return in excess amount more in comparison of return to its benchmark.
Now we may have come to a question how this alpha practically gets generated and answer to this is due to the fund manager’s skills. Here, the job of fund manager plays a very crucial role in determining the value of Alpha for the fund he manages. There could be possibility that fund manager for Scheme A taken in the above example have got new ideas about investments which has resulted in making 5 % more return compared with its benchmark and on the other side Fund manager of Scheme B could not.
What is beta β?
Volatility plays a very crucial role in measuring the returns a particular stock or any investment instrument under consideration. Every individual investor has to be informed and undergoes the concept of Volatility. Now let us understand the concept of volatility from mutual fund scheme angle. Volatility associated with the scheme means how much volatile are the stocks considered under the schemes portfolio with respect to their average. And other side is how much mutual fund scheme return fluctuates with respect to its benchmark. off course with the time under consideration. This concept is called as Beta. In simple language we can say how much the scheme return gives for every respective return given by its benchmark for a particular period of time. It is determination of its relation between the schemes returns deviation from its benchmarks returns.
Now let us understand practically, if Scheme A generates 10% for every 5% return to its benchmark then its Beta value is 2 and on the other side if Scheme A gives returns of 5% for every 10% returns by its benchmark then we can its Beta value is 0.5. This means, Beta value of less than one indicates change in the portfolio prices is less than its benchmark and Beta value of greater than one indicates change in the portfolio prices more than its benchmark.
Now every individual wants to be with Higher Beta Values when the market goes up but on the other side when market is downwards then every individual wants to be with low beta value to protect their capital. Here the role of investment advisor comes into picture while suggesting any scheme to the individual investor for investment.
Generally mutual fund scheme which consist of high beta stocks could have high alpha.