Equity mutual funds: Evaluate risks in a equity fund via Beta value

January 05, 2021 12:45 AM

Beta, which measures the volatility of a scheme’s NAV compared with its benchmark index, can help identify mutual fund schemes that mirror your risk appetite

The Beta value itself is available in the Fund Factsheet, a marketing and information document circulated to investors by all fund houses on a monthly basis.

By Hemanth Gorur

Equity mutual fund schemes are known to be riskier than debt schemes or liquid fund schemes. This is common knowledge. However, what if one wants to compare within equity mutual fund schemes to see which fund is riskier?
One of the ways of doing that is to see the Beta value of the mutual fund scheme. Comparing the Beta values of two different equity mutual fund schemes can tell you which one is riskier. This article tells you how exactly to do that.
Systematic and unsystematic risk

Any equity mutual fund scheme carries a certain amount of risk with it. This risk is the probability of incurring a loss on your investment. It helps to think of this risk as being made up of two components: systematic risk and unsystematic risk. Systematic risk is the risk associated with the market itself. Typically, the “market” is a select group of stocks that represent the entire universe of stocks being transacted. Often, this is represented by a diversified stock index being tracked.

Systematic risk affects all stocks in the market and hence cannot be diversified away ie., nullified. This is because the underlying factors that affect one company’s stock affect all companies’ stocks. For example, when the economy is going down, all stock prices will drop. Unsystematic risk, on the other hand, affects only specific companies. This is because the underlying factor generating the risk may be limited to only the company in question. For example, when a company’s patent gets rejected, its stock price may fall, but other companies may not be affected. Unsystematic risk can be diversified away.

What is Beta and where to find it?
Beta of a mutual fund scheme is a measure of the systematic risk associated with it. It measures the volatility of the scheme’s Net Asset Value (NAV) in comparison with its benchmark index. The benchmark index is a diversified stock index composed of stocks that closely resemble the investment objective, asset allocation, and investment strategy of the mutual fund scheme in question. This benchmark index can be different for different mutual fund schemes.

All the above information is available in the Scheme Information Document (SID), a public document containing the details of the mutual fund scheme. The SID is available on the official websites of Securities & Exchange Board of India (SEBI), Association of Mutual Funds in India (AMFI), and the Asset Management Company (AMC) that has launched the scheme. The Beta value itself is available in the Fund Factsheet, a marketing and information document circulated to investors by all fund houses on a monthly basis.

How to interpret Beta values to gauge risk of MF
By definition, the Beta of the diversified stock index (representing the market) is 1.0. If the Beta of a mutual fund scheme is 1.0, then it reacts in tandem with the market. If the market rises by 10%, then the mutual fund scheme will rise by 10%.

If the Beta of a mutual fund scheme is more than 1.0, it is more volatile than the market. If the Beta of the mutual fund scheme is, say 1.3, and the market falls by 5%, then the mutual fund scheme’s NAV will fall by 6.5%, i.e., the price fluctuation is amplified. This happens with any price rise too. This type of scheme is suitable for investors who do not mind taking on higher risk in the hope of landing higher returns.

If the Beta of a mutual fund scheme is less than 1.0, it is less volatile than the market. If the market rises or falls by 5%, a mutual fund scheme with Beta of 0.7 would rise or fall by just 3.5%. This type of scheme is suitable for conservative investors.
Using Beta, one can identify mutual fund schemes that mirror one’s risk appetite and hunger for returns.

What beta says
Beta of a mutual fund scheme is a measure of the systematic risk associated with the scheme
By definition, Beta of the diversified stock index is 1.0. If the Beta of a mutual fund scheme is 1.0, then it reacts in tandem with the market
If the Beta of a mutual fund scheme is more than 1.0, it is more volatile than the market
nIf the Beta of a mutual fund scheme is less than 1.0, it is less volatile than the market

(The writer is founder, Hermoneytalks.com)

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