Equity mutual fund systems are known to be riskier than debt systems or liquid fund schemes. This is in public knowledge. However, what if one wants to compare within equity mutual fund systems to recognize which fund is riskier? One of the techniques of doing that is to recognize the Beta advantage of the mutual fund scheme. Analyzing the Beta values of two different equity mutual fund schemes can advise you which one is riskier. That article tells you how specifically to do that.
Systematic and unsystematic risk
Any equity mutual fund system carries a certain amount of risk with it. This risk is the probability of acquiring a loss on your investment. It helps to think of this risk as being manufactured up of two components: systematic risk and unsystematic risk. Systematic risk is the risk associated with the business itself. Typically, the “market” is a select group of stocks that represent the entire nature of stocks being transacted. Often, this is represented by a diversified stock index remaining tracked.
Systematic risk affects all stocks in the market and hence cannot be expanded away ie., nullified. This is because the underlying circumstances that affect one company’s stock move all companies’ stocks. For example, when the administration is going down, all stock prices will drop. Unsystematic risk, on the other round, affects only specific companies. This is because the underlying factor causing the risk may be limited to only the company in the issue. For example, when a company’s patent gets declined, its stock price may fall, but other companies may not be interested. Unsystematic risk can be increased away.
What is Beta and where to spot it?
The beta of a mutual fund scheme is a type of systematic risk associated with it. It measures the evaporation of the scheme’s Net Asset Value (NAV) in connection with its benchmark index. The benchmark index is a diversified stock index constituted of stocks that closely resemble the investment objective, asset allocation, and investment policy of the mutual fund scheme in question. This benchmark index can be changed for different mutual fund schemes.
All the above information is available in the Scheme Information Document (SID), a public document including the details of the mutual fund scheme. The SID is available on the official websites of the Securities & Exchange Board of India (SEBI), Association of Mutual Funds in India (AMFI), and the Asset Management Company (AMC) that has originated the scheme. The Beta value itself is possible in the Fund Factsheet, a marketing and information document distributed to investors by all fund houses every month.
How to understand Beta values to gauge the risk of MF
By description, the Beta of the diversified stock index (representing the market) is 1.0. If the Beta of a mutual fund system is 1.0, then it reacts in tandem with the market. If the market increases by 10%, then the mutual fund scheme will rise by 10%.
If the Beta of a mutual fund scheme is higher than 1.0, it is more subtle than the market. If the Beta of the mutual fund scheme is, say 1.3, and the market declines by 5%, then the mutual fund scheme’s NAV will decrease by 6.5%, i.e., the price fluctuation is amplified. This happens with any price growth too. This type of scheme is suitable for investors who do not remember taking on higher risk in the hope of landing higher returns.
If the Beta of a mutual fund scheme is shorter than 1.0, it is less volatile than the market. If the market rises or decreases by 5%, a mutual fund scheme with a Beta of 0.7 would rise or decline by just 3.5%. This type of scheme is suitable for traditional investors.
Using Beta, one can distinguish mutual fund schemes that mirror one’s risk appetite and hunger for returns.
What beta states
The beta of a mutual fund scheme is a standard of the systematic risk associated with the system. By definition, the Beta of the diversified stock index is 1 now. If the Beta of a mutual fund system is 1.0, then it reacts in tandem with the exchange. If the Beta of a mutual fund scheme is more numerous than 1.0, it is more volatile than the market of the Beta of a mutual fund scheme is scarcer than 1.0, it is less volatile than the market.