How to choose the best mutual funds using quantitative techniques: Standard Deviation, Sharpe Ratio and more

Mutual fund investments(MFI) are subject to market risks. However, there are various quantitative measures in the Modern Portfolio Theory (MPT) that can help to objectively analyse your MFIs for potential risks and volatility to make a more educated decision.

Here's how to choose the best mutual funds using quantitative techniques

4 factors to consider when selecting mutual funds with quantitative factors

When it comes to investing in mutual funds, there is no “one size fits all” system!

Mutual fund investments(MFI) are subject to market risks. However, there are various quantitative measures in the Modern Portfolio Theory (MPT) that can help to objectively analyse your MFIs for potential risks and volatility to make a more educated decision. Choosing a mutual fund investment subjectively depends entirely on your financial goals, risk appetite, and asset allocation. 

With over 1,500 schemes out there in the mutual fund (MF) industry and more getting added every other day, there are many options for investors to choose from. But if you plan to invest directly in MFs, apart from the past performance, here are four quantitative measures that can help you make sense of your MFI.

Also Read: Best Equity Mutual Funds to Invest in India

1. Standard Deviation:

Standard Deviation is a measure of dispersion that indicates how much the data deviates from the average. While selecting mutual funds, standard deviation indicates the deviation of actual returns from the expected returns based on their historical performance.

The more spread out the data (Returns), the more standard deviation the fund’s returns will have, indicating high volatility in returns and therefore, high risk. Hence, this is a great measure for adjusting your funds according to your risk appetite. 

2. Sharpe Ratio:

The Sharpe ratio is one of the most popular methods for calculating risk-adjusted returns. The Sharpe ratio is used by investors to understand the return on investment compared to its risk. A Sharpe ratio greater than 1 indicates a fund has a higher return to risk ratio, which is ideal. However, generally, investors compare the Sharpe Ratios of multiple funds to select the funds with a higher Sharpe Ratio to limit the risks and maximise gains. 

3. Beta Coefficient:

Beta Coefficient is used to understand the volatility of a fund compared to the market as a whole. Under this method, Market Beta is considered 1. If the individual MF’s Beta is less than 1, it indicates lesser volatility than the market and a value more than 1 reflects more volatility. For example, if XYZ Mutual Fund has a 0.8 Beta coefficient, it indicates that this particular fund is less volatile than the market. Thus, you can choose the mutual funds according to the level of volatility you are comfortable with. 

4. Portfolio:

All mutual funds mandatorily exhibit where the funds allocated will be invested, whether they will be invested in small companies or large companies. It also shows if the companies included in the portfolio exhibit growth or value characteristics.

For equity and hybrid funds, portfolio analysis helps you determine asset allocation and company/sector allocation of the funds. The debt fund portfolio exhibits credit quantity, instrument breakup, and related quantitative data(Average maturity period, yield, etc.). All this information can be found in the factsheets of the funds and can help you make a more informed choice. 

Also Read: Best Arbitrage Mutual Funds To Invest in India

Conclusion:

All investments carry risks, and mutual funds aren’t immune to that. However, it is still safer than owning individual stocks. Thus, mutual funds are a highly lucrative and easy investment option available for you. Depending on your risk appetite observe the data available about the fund and make an educated decision on your investments. 

https://www.tomorrowmakers.com/mutual-funds/best-equity-mutual-funds-invest-india-article

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