Investing in top mutual funds requires understanding the risks involved. Two key metrics that help assess the risk of a mutual fund are volatility and beta. Let’s take a deeper look at these factors in the context of the Indian mutual fund industry.
Volatility
Volatility measures the fluctuation of returns of a mutual fund over a period of time. It indicates how much the NAV or price of a fund fluctuates upwards and downwards from the average returns. Mutual funds with high volatility carry more risk since their NAV can swing significantly from month to month or year to year.
The standard deviation of returns is commonly used to measure the volatility of a fund over a period of 1 year, 3 years or 5 years. A higher standard deviation number indicates higher volatility. For example, an equity fund may have an annualized standard deviation of 15-20% which is considered high, while a debt fund’s standard deviation is usually lower around 3-5%.
In India, small cap and mid cap funds tend to be more volatile compared to large cap or multi cap funds. Sector and thematic funds concentrating their investments in specific areas also carry higher volatility risk depending on the performance of their chosen sectors. For conservative investors, low volatility funds like liquid, overnight, or corporate bond funds are better choices.
Beta
Beta is another risk metric that compares the volatility of a fund to the overall market. It measures the sensitivity of a fund’s returns compared to the benchmark index returns. A beta of 1 means the fund moves with the index – it is as volatile as the index.
A beta greater than 1 indicates the fund is more volatile than the market. For example, mid and small cap funds tend to have higher betas between 1.1-1.5 times the index. A beta lower than 1 means the fund is less volatile than the index. Debt funds usually have betas below 1, while large cap index or passive funds have betas close to 1.
Risk minimization through an SIP
The risks associated with mutual funds, especially equity funds, can be minimized through the SIP or systematic investment plan mode of investing. Rather than investing a large lumpsum amount, an SIP allows rupee cost averaging by investing small amounts regularly, say Rs. 1000-5000 each month.
Diversification to control risk
In addition to understanding volatility and beta of individual funds, proper diversification across asset classes also helps control overall portfolio risk for investors. Allocating funds across large cap, multi cap, mid cap, small cap, debt, gold and international funds provides diversification benefits.
Conclusion
Volatility, beta, SIPs and diversification are important risk concepts for Indian investors to understand to build sustainable wealth via mutual funds. Carefully selecting funds based on these metrics tailored to one’s financial goals and risk profile can optimize returns within defined risk parameters. Regular tracking and portfolio course correction at suitable intervals further helps manage risks effectively over different market cycles.