Mutual Fund Technicals
MUTUAL FUNDSTERMINOLOGY
A comprehensive list of all important technical terminology one should know before investing in an mutual fund or any portfolio in general.
NAV (Net Asset Value) = (Total Assets - Total Liabilities) / Number of Outstanding Shares. NAV is like the stock price equivalent of a MF or ETF. NAV does not matter and usually investors see it but it is pointless as say if NAV is 10 and I buy 3 then I am investing 30. Similarly, if NAV is 5 and I am investing 30 then I will just buy 6 stocks.
Sharpe Ratio is the comparison of the return of an investment upon its underlying risk. Now there are 2 main things here, the return of investment and also the underlying risk. The return on investment is the difference of returns (percentage returns) and the risk-free returns (In India it is the 10-year government bond returns as it is considered risk-free). The risk is the standard deviation of the same return over the same time period as the deviation is the measure of risk/volatility.
Sortino Ratio is the same as Sharpe Ratio, the only difference is here we take the downside risk and not the actual risk. The downside risk is the standard deviation of only the negative returns. So downside risk = root of sigma(min(Ri - Rf, 0))/N.
Capital Asset Pricing Model (CAPM) is just a formula as E[Ri] - Rf = beta (E[Rm] - Rf), where Ri = Returns of the portfolio, Rf is the risk-free returns and Rm is the returns of some market portfolio (In India, say Nifty). The beta is the cov(Ri, Rm)/Var(Rm), it is the risk profile, so beta more than 1 means our portfolio is more risky than the market and less than 1 means it is less risky than the market portfolio.
Jensen’s Alpha = Rp - [Rf + beta(Rm - Rf)] so here this means that alpha is the excess returns the portfolio gets. Rp is the portfolio’s actual return, Rf is the risk-free rate and so Rf + beta(Rm - Rf) is the expected returns of the portfolio and when we subtract it with Rp we get the excess returns a portfolio makes. So more positive alpha means that the portfolio outperformed and negative means underperformance by the CAPM model.
R Squared is 1 - SSr/SSt, where SSr is the sum of square of residuals, where it is sigma square of Ri - Rp where Rp is the predicted returns using some linear model. SSt is the total variance and is the sigma square of Ri - modR where modR is the mean of returns by the portfolio. R squared captures the essence of how well the portfolio ’s returns are explained by the market. If R squared is 0.82 then 82% of the portfolio’s returns are explained by the market (In India it is the Nifty index).
Downside and Upside Deviation is the downside risk and the upside risk (see Sortino ratio denominator). The downside deviation is the standard deviation of the returns that fall below a threshold (here it is Rf). Similarly, the upside deviation is the standard deviation of the returns that fall above a threshold (here it is Rf). A less than 5 percent means that the portfolio has excellent or minimal downside risk. A good upside deviation is 5% to 10%. More than 15 means that the portfolio is very aggressive and has significant potential for high returns.
Downside and Upside Capture Ratios are two very important ratios. The downside capture ratio or downside portfolio returns / downside market returns indicate how better is the downside protection of the portfolio. If this value is less than one then it means that the portfolio is doing really well when it comes to downside protection. The upside ratio is the same but for the upside returns of the portfolio / the market upside returns. A value of more than one is a good thing as it means that the portfolio is making more than the market in the upside trend.
AUM is the average asset under management and when we take the fund’s expense * 100 and divide by the AUM we get the expense ratio. A high expense ratio reduces the net returns for the investors and say if the fund is making 10% returns then what the investors will get at the end of 1 year is 10% - expense ratio.
CAGR or Compound Annual Growth Rate is how much returns we get after a year as the returns are compounded. So after say 10 days if the fund makes 2% then now instead of using 100% of what was put in, the fund uses 102% of then hopefully does the same. Here a CAGR of 15% will double the money put in after 5 years. Similarly, a CAGR value of 32% can double your money in 2.5 years.