Skip to main content

High Alpha Funds or Low Beta Funds


 
 
For investors in actively managed equity mutual funds, the worth of a fund lies in how much return it is able to generate over that given by the relevant benchmark. So, at a basic level, the choice of fund will have to be driven by how much value a fund manager is adding vis-a-vis an index.

Alpha, which measures this value addition, is often taken as a metric to gauge fund performance. Investors who seek outperformance would be drawn towards funds running a higher alpha. But can investors always benefit from the pursuit of high alpha?

IMPORTANCE OF ALPHA

Simply told, alpha is the excess return delivered by a fund over its benchmark index. But more precisely , it is the excess return or value generated by a fund manager over the fund's expected return. This expected performance is based on the risk taken by the fund manager relative to the market, which is defined by beta.

Thus, a fund's alpha is derived from its underlying beta. A beta value of 1.5 indicates the fund would deliver 1.5% return for every 1% gain in the value of its underlying index.

Suppose a fund with a beta of 1.5 delivers a return of 18% over a certain period while its underlying benchmark index posts 12% returns. Given the beta, the fund manager would be expected to deliver a return of 18% (12%*1. 5). So, in this case, the fund manager has actually failed to generate alpha even though the fund has delivered 6% excess return over its benchmark.

If the fund delivered a return of 20% for the same underlying risk, the alpha generated would be 2%. Which implies that alpha represents the fund manager's expertise in stock selection or portfolio building. Most top-performing funds over longer time periods boast of a high alpha. In most cases, if a fund has generated high alpha in the past, it is likely to generate the same in the future too. Thus, it would bode well for investors to pay attention to a fund's alpha when selecting equity funds.

However, experts insist that consistency in delivering alpha is critical. Certain funds are good at delivering alpha only during a market uptrend.The fund should show consistency in generating alpha across various time frames and market cycles. Alpha can be a good indicator of a fund manager's ability provided there is consistency in the philosophy and processes driving the portfolio selection. Also, bear in mind that extent of alpha varies between fund categories. Typically, mid-cap oriented equity funds are able to deliver higher alpha than large-cap oriented ones. While mid-cap funds can comfortably clock alpha in excess of 8-10%, alpha in large-cap funds is typically lower.

WHERE ALPHA MAY NOT WORK

Alpha as a metric has a few shortcomings, which can make its extensive use counter-productive. First, alpha depends on the underlying benchmark index for the fund. Even though we may measure it in absolute terms, alpha is actually a relative measure dependent on market proxy . This can have several implications.

It can prevent effective comparison between funds, even within the same fund category . Since different equity funds within the same category also tend to be benchmarked against different indices, the alpha statistic will measure outperformance relative to that benchmark. You can end up comparing apples to oranges.

Besides, since it measures performance relative to beta, the accuracy of alpha depends on the credibility of the beta measure. The beta value of a fund may be flawed if its correlation to the underlying index is very low. So, a fund's alpha may be misleading if it does not have high correlation to the benchmark it is being compared with.
 

Another gripe analysts have with using alpha is that it is ignorant of the risk-adjusted performance. While it measures excess return given the level of market risk, it makes no adjustment for the risk involved in delivering that additional performance. As such, experts insist that alpha should not be used in isolation while picking funds.It should be supplemented with other metrics to really gain true understanding of the performance of the fund. Investors give equal importance to the underlying risk.  Go with a fund offering healthy alpha but lower beta.

Birla Sun Life Pure Value, for example, has delivered a healthy alpha of 10% over the past five years with a beta of 1.06. Its peer in the same category , BNP Paribas Midcap Fund has delivered similar return although at a lower beta of 0.83. Belapurkar says just looking at alpha does not provide the entire picture. Investors need to dissect the number further to see where the alpha is actually coming from. If it is due to a high risk taken by the fund manager, then it could be a red flag. Investors need to consider other risk factors apart from beta.

For instance, a large-cap fund taking high exposure to midor smallcap stocks would likely fetch a high alpha but that doesn't reflect the fund manager's acumen. Finally, investors should understand that past performance is not and never should be relied on as indicator of future performance.

 Buy Mutual Fund Online

-----------------------------------------------
Invest Rs 1,50,000 and Save Tax under Section 80C. Get Great Returns by Investing in Best Performing ELSS Mutual Funds

Top 10 Tax Saver Mutual Funds to invest in India for 2017

Best 10 ELSS Mutual Funds in India for 2017

1. BNP Paribas Long Term Equity Fund

2. Axis Tax Saver Fund

3. Franklin India TaxShield

4. ICICI Prudential Long Term Equity Fund

5. IDFC Tax Advantage (ELSS) Fund

6. Birla Sun Life Tax Relief 96

7. DSP BlackRock Tax Saver Fund

8. Reliance Tax Saver (ELSS) Fund

9. Religare Tax Plan

10. Birla Sun Life Tax Plan

Invest in Best Performing 2017 Tax Saver Mutual Funds Online

Invest Online

Download Application Forms

For further information contact Prajna Capital on 94 8300 8300 by leaving a missed call

---------------------------------------------

Leave your comment with mail ID and we will answer them

OR

You can write to us at

PrajnaCapital [at] Gmail [dot] Com

OR

Leave a missed Call on 94 8300 8300

-----------------------------------------------

Popular posts from this blog

All about "Derivatives"

What are derivatives? Derivatives are financial instruments, which as the name suggests, derive their value from another asset — called the underlying. What are the typical underlying assets? Any asset, whose price is dynamic, probably has a derivative contract today. The most popular ones being stocks, indices, precious metals, commodities, agro products, currencies, etc. Why were they invented? In an increasingly dynamic world, prices of virtually all assets keep changing, thereby exposing participants to price risks. Hence, derivatives were invented to negate these price fluctuations. For example, a wheat farmer expects to sell his crop at the current price of Rs 10/kg and make profits of Rs 2/kg. But, by the time his crop is ready, the price of wheat may have gone down to Rs 5/kg, making him sell his crop at a loss of Rs 3/kg. In order to avoid this, he may enter into a forward contract, agreeing to sell wheat at Rs 10/ kg, right at the outset. So, even if the price of wheat falls ...

ICICI Prudential Balanced Fund

 ICICI Prudential Balanced Fund scheme seeks to generate long-term capital appreciation and current income by investing in a portfolio that is investing in equities and related securities as well as fixed income and money market securities. The approximate allocation to equity would be in the range of 60-80 per cent with a minimum of 51 per cent, and the approximate debt allocation is 40-49 per cent, with a minimum of 20 per cent. An impressive show in the last couple of years has propelled this fund from a three-star to a four-star rating. The fund has traditionally featured a high equity allocation, hovering at well over 70 per cent, which is higher than the allocations of the peers. But in the last one year, the allocation has been moderated from 78-79 per cent levels to 66-67 per cent of the portfolio. ICICI Prudential Balanced Fund appears to practise some degree of tactical allocation based on market valuations. Within equities, well over two-thirds of the allocation is parked i...

SBI bonds FAQ

  Maximum retail subscription and over – subscription There is a lot of excitement around these bonds, so I won't be surprised if they get over-subscribed on the first day itself. So, I thought Sameer asked a very good question about over-subscription. Here is that discussion. Here are some other questions that you may find useful. Can I trade the SBI bonds on NSE after it lists? Yes, these can be traded after listing. Where can I get the application forms, and can I buy the bonds online? You can get the application from notified branches, and then fill it up there and submit it. To the best of my knowledge, there is no way to invest in them online, but if anyone knows otherwise then please leave a message, and let us know. Can NRIs apply for these bonds? NRIs can't apply for these bonds as they fall under one of the ineligible categories. Can you take a loan by keeping the SBI bonds as security? The terms of the issue in the prospectus state that the bank shall no...

Tax Planning: Income tax and Section 80C

In order to encourage savings, the government gives tax breaks on certain financial products under Section 80C of the Income Tax Act. Investments made under such schemes are referred to as 80C investments. Under this section, you can invest a maximum of Rs l lakh and if you are in the highest tax bracket of 30%, you save a tax of Rs 30,000. The various investment options under this section include:   Provident Fund (PF) & Voluntary Provident Fund (VPF) Provident Fund is deducted directly from your salary by your employer. The deducted amount goes into a retirement account along with your employer's contribution. While employer's contribution is exempt from tax, your contribution (i.e., employee's contribution) is counted towards section 80C investments. You can also contribute additional amount through voluntary contributions (VPF). The current rate of interest is 8.5% per annum and interest earned is tax-free. Public Provident Fund (PPF) An account can be opened wi...

Fortis Mutual Fund

Fortis Mutual Fund, a relatively new player, it is still to prove its case and define its position in the industry. In September 2004, it came onto the scene with a bang - three debt schemes, one MIP and one diversified equity scheme. And investors flocked to it. Going by the standards at that time, it had a great start in terms of garnering money. Mopping up over Rs 2,000 crore in five schemes was not bad at all. The fund house has not been too successful in the equity arena, in terms of assets. Though it has seven equity schemes, it is debt and cash funds that corner the major portion of the assets. Most of the schemes are pretty new, and the two that have been around for a while have a 3-star rating each. The last two were Fortis Sustainable Development (April 2007), which received a rather poor response, and Fortis China India (October 2007). Fortis Flexi Debt has been one of the better performing funds, after a dismal performance in 2005. It currently has a 5-star rating. None ...
Related Posts Plugin for WordPress, Blogger...
Invest in Tax Saving Mutual Funds Download Any Applications
Transact Mutual Funds Online Invest Online
Buy Gold Mutual Funds Invest Now