Beta in mutual funds represents market risk or systematic risk. Standard Deviation measures volatility of fund in comparison to its mean return but beta measures sensitivity of a fund to its benchmark/index. (Sounds alien – let’s make it simple)
How often have you tuned into a business channel or opened the pages of a pink paper to be told where the markets are headed? The word currently going around is that markets should move up by approximately 25 per cent in the next year. (added just to make you happy) This seems so reassuring. Wouldn’t it be equally reassuring if one could get an indication of how a mutual fund would perform in the future? Especially when all performance data is just an indication of how a fund has performed in the past. And more so when this ‘past performance’ is accompanied by the warning that it may or may not be replicated in the future.
What is Beta ?
There are statistical tools, which can give you an idea of how a fund will move in relation to the market. Beta is a statistical measure that shows how sensitive a fund is to market moves. If the Sensex moves by 25 per cent, a fund’s beta number will tell you whether the fund’s returns will be more than this or less.
The beta value for an index itself is taken as one as it is expected that this funds will just mimic INDEX.(so you would have heard this song “tu jahan jahan rahega mera saya saath hoga”) Equity funds can have beta values, which can be above one, less than one or equal to one. By multiplying the beta value of a fund with the expected percentage movement of an index, the expected movement in the fund can be determined. Thus if a fund has a beta of 1.2 and the market is expected to move up by ten per cent, the fund should move by 12 per cent (obtained as 1.2 multiplied by 10). Similarly if the market loses ten per cent, the fund should lose 12 per cent (obtained as 1.2 multiplied by minus 10)
This shows that a fund with a beta of more than one will rise more than the market and also fall more than market. Clearly, if you’d like to beat the market on the upside, it is best to invest in a high-beta fund. But you must keep in mind that such a fund will also fall more than the market on the way down. So, over an entire cycle, returns may not be much higher than the market.
Beta in Mutual Funds
SBI Magnum Tax Gain fund was made open ended in 1999 & it was managed by Sandip Sabharwal till November 2005. You can check the beta of the fund in comparison to its peers – Yellow line.
Performance of a High Beta Mutual Fund
You can clearly see how a fund with high beta performs in different market cycles.
Similarly, a low-beta fund will rise less than the market on the way up and lose less on the way down. When safety of investment is important, a fund with a beta of less than one is a better option. Such a fund may not gain much more than the market on the upside, it will protect returns better when market falls.
So beta seems to be just what the doctor ordered. But as in the case of all things which seem to be too good to be true, there is a catch. The problem is that beta depends on the index used to calculate it. It can happen that the index bears no correlation with the movements in the fund. Thus if beta is calculated for large cap fund against a mid-cap index, the resulting value will have no meaning. This is because the fund will not move in tandem with the index.
R-Squared in Mutual Funds
Due to this reason, it is essential to take a look at a statistical value called R-squared along with beta. The R-squared value shows how reliable the beta number is. It varies between zero and one. An R-squared value of one indicates perfect correlation with the index. Thus, an index fund (check DSP Equal Weight Index Fund) investing in the Sensex should have an R-squared value of one when compared to the Sensex. For equity diversified funds, an R-squared value greater than 0.8 is generally accepted to mean that the underlying beta value is reliable and can be used for the fund.
Beta and R-squared should thus be used together when examining a fund’s risk profile. They are as inseparable as risk and return.
Some Funds with high & low beta
(data March 2011)
|JM Emerging Leaders|
|Magnum Emerging Businesses|
|L&T Small Cap|
|Canara Robeco Emerging Equities|
|IDFC Premier Equity Plan A|
|Reliance Long Term Equity|
|Principal Dividend Yield|
|Tata Dividend Yield|
|Birla Sun Life Dividend Yield Plus|
|Escorts High Yield Equity|
Findings from above Beta table:
- Someone who has ever invested in mutual funds can clearly see that why JM funds were so volatile.
- Escorts Growth has R-Squared of .69 – data is unreliable similar to this fund
- Birla Sun Life Dividend Yield Plus beta is low so if you see last 3 years data it is one of the best performing fund. Will it participate in next Bull Run – check its performance when SENSEX touches 40000.
If you like this article you must read about Standard Deviation in Mutual Funds – which tells you about volatility/risk of a particular fund or portfolio.
Do you think it’s important to see factors other than returns while choosing a fund?