As inflows into mutual funds increase, it is important for investors to understand key ratios before investing in them. According to Nasser Salim, Managing Partner at Flexi Capital, standard deviation and sharpe ratio are some of the key indicators to watch out for.
What is Standard Deviation?
Standard deviation is one of the most common and important ratios to track. It indicates volatility by measuring how much a portfolio’s return deviates from its average.
"To use standard deviation as a performance ratio, you need to compare two mutual funds belonging to the same category. A high standard deviation indicates a wider range of returns whereas a lower value indicates a narrow range of return and lower risk on return that is being generated," explains Salim.
What is Sharpe Ratio?
Sharpe ratio is another important indicator which helps in estimating a fund's risk-adjusted return. Risk-adjusted returns are returns that a fund generates over and above the risk-free rate of return.
"The sharpe ratio aids in determining a funds return generating capacity for each unit of risk it absorbs," says Salim.
“These ratios - metrics cannot be used in isolation and investors must consult an expert, distributor or an advisor in the mutual fund space. These ratios have to be used collectively to understand the importance of risk adjusted returns," he adds.
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