Alpha and Beta to calculate the risk:
Alpha and Beta are two important metrics for assessing risk in a mutual fund. Alpha measures the risk-adjusted returns of a mutual fund. Beta indicates a fund’s sensitivity to market movements.
Alpha measures a mutual fund’s performance relative to a benchmark index, adjusted for risk. It tells you whether the fund manager has outperformed or underperformed the market.
✅ Interpretation:
- Positive Alpha: Fund beat the market after adjusting for risk.
- Negative Alpha: Fund underperformed the market.
- Alpha of 0: Fund performed exactly in line with expectations.
The formula that calculates alpha is: Alpha = R – Rf – beta (Rm – Rf). In this formula, R represents the portfolio’s return, Rf represents the risk-free rate of return, beta represents the systematic risk of a portfolio, and Rm represents the market return for each benchmark.
Where:
- R_i = Return of the investment (mutual fund)
- R_f = Risk-free rate (e.g., government bond yield)
- \beta = Beta of the fund
- R_m = Return of the market (benchmark index)
Beta measures a fund’s volatility or systematic risk compared to the market. This reveals the dynamic interplay between the fund’s returns and the benchmark.
✅ Interpretation:
- Beta = 1: Fund moves in line with the market.
- Beta > 1: Fund is more volatile than the market.
- Beta < 1: Fund is less volatile (more conservative).
β = covariance(stock returns, index returns) / variance(index returns).
🧠 Why It Matters for You
As someone methodical and analytical in comparing mutual fund options:
- Use Alpha to judge a fund manager’s skill.
- Use Beta to assess risk exposure and portfolio stability.
For example, if you’re building a 3-year portfolio with a mix of growth and safety:
- A high Alpha, low Beta fund might offer smart returns with lower risk.
- A high Beta fund might suit short-term aggressive plays, but not long-term stability.