What is Alpha and Beta in Mutual Funds

The alpha and beta are the two most commonly used instruments in the financial market. The alpha and beta are used for quantifying the performances, responses, and interactions of mutual funds in the stock market.

In this article, we will talk about what alpha and beta ratios are in mutual funds, why they are important, and how to calculate these ratios.

Alpha is representative of the performance of an asset manager in terms of guiding a mutual fund into yielding profits, as compared to the benchmark index. On the other hand, beta is for registering and quantifying a mutual fund’s response to volatility in the market; which is, the degree of conformity in the prices of the fund as a result of changes in the benchmark index.

The baseline is 0 for alpha in mutual funds. This figure of 0 indicates the performance graph of an asset manager to be in line with the benchmark index precisely. Any figures in negatives suggest that the asset manager’s performance has been underwhelming. A figure higher than 0 for alpha in mutual funds is representative of the fund manager having outperformed the benchmark index.

The baseline is 1 for beta in mutual funds. This figure of 1 indicates that a fund responds to volatility in the market equivalently. This is indicative of the shift in the fund’s price as per the benchmark movements. A figure greater than 1 would represent that the fund has demonstrated a rather significant shift in terms of its prices, as compared to the benchmark movement. On the other hand, a figure below 1 says the opposite.

• Alpha and beta in mutual funds are two important instruments of the investment markets.
• Alpha and beta ratios are important because they tell you about the past performance of a particular mutual fund.
• Though these predictions might prove to be different from actual results, it still gives a broad picture to the prospective investor for his decision.

While investing in mutual funds, it is important to check its past performance to make the right investment decisions.

Ratios play a very important role in analysing the history of a fund vis-a-vis various market phases. It will also give you relevant statistics to estimate prospects in the near future – growth prospects, risks involved, sustainability, etc.

The alpha ratio is beneficial for you as an investor since it can guide you in deciding whether an asset or a fund should be pursued or not based on the asset manager's capacity to earn profits.

Likewise, a beta ratio in mutual funds informs the investors about the level of volatility a Mutual Fund tends to display for the fluctuations that appear in the market.

The formula to calculate alpha in mutual funds is:

(End Price + DPS - Start Price)/Start Price

Wherein, DPS stands for Distribution Per Share.

The alpha in mutual funds can alternatively be calculated using CAPM. Since CAPM is indicative of the returns expected from a particular fund, any number that deviates from the same would be the alpha.

The formula to calculate beta in mutual funds is:

Covariance/Variance of the market returns

Beta in the context of mutual funds is a two-ingredient calculation: namely, covariance and variance. The term covariance refers to how two different stocks respond to one another under the influence of varying conditions in the market. A positive covariance would indicate that two stocks move with each other, while a negative covariance would indicate that two stocks move against each other.

Variance is directly related to the price movement of a fund from the average or mean and denotes the price volatility of that fund for a given period.

As an investor, it is always important to be aware of the ratios associated with mutual funds. It helps you make an informed decision while choosing a fund to invest in.

The Bajaj Finance Mutual Fund Platform offers more than 1,000 mutual funds schemes that you can invest in. The platform’s mutual fund calculator further helps you compare mutual funds.