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There are multiple parameters in mutual fund analysis, but the beta is considered one of the most important factors. Let’s understand the meaning and importance of beta in more detail.
In CAPM, beta measures systematic risk. The ratio measures how closely a security's return moves with the return of the stock market as a whole. So, beta can be considered a statistical measure that gives us an idea about relative volatility. Beta indicates the volatility of a portfolio (in our case, a mutual fund). It shows how a fund will perform with respect to the overall market. Beta can be used as an indicator of how volatile a fund is compared to its benchmark.
You can find the beta of any mutual fund in the performance section of the fund in sharpely.
In the above image, we can see that the beta is 0.84, which means when the benchmark, which is the Nifty 500 TRI for this fund, increases by 1%, the fund will increase by 0.84% and vice versa. This means the fund is less volatile compared to the benchmark. Likewise, if the beta is greater than 1, then the fund is more volatile.
As an investor, you should have a good mixture of high-beta and low-beta mutual funds. This will help you generate good returns during a market upcycle (due to high beta funds) and will help you protect your downside during the downcycle (due to low beta funds).
Beta should be compared for funds in the same category or, to be more precise, for funds with the same benchmark. For example, you should compare beta to two large-cap funds. You should not compare the beta of a large-cap fund with a small-cap fund as both stock types (large-cap and small-cap) will have a different benchmark.
As we can see, mutual funds in the same category can have different beta values. Beta can help you in selecting the mutual fund. For example, risk-averse investors may avoid funds with high beta values as they can be more volatile.
The value of beta can be less than or greater than 1. The higher the value of beta, the more volatile will be the fund. The value of beta can even be negative as well. In such cases, the mutual fund will give opposite returns compared to the benchmark. For example, if the benchmark goes down then the fund’s return will be positive and vice versa.
You can consider beta as a parameter when selecting the mutual fund category as well. But, beta alone can not help you in your investment decisions. You have to analyze other factors as well before making an investment decision - We discuss that in detail here.
For beta calculation, you need historical data of the fund as well as its benchmark. Ideally, the past 3 years of data should be used. You need to calculate the covariance of the fund's return and benchmark’s return as well as the variance of the benchmark’s return. You may have to use statistical tools like Excel for the calculation. After calculating both, the beta can be calculated as
Beta = Covariance (MF return, Benchmark return) / Variance (Benchmark return)
High value of beta indicates higher price movements of the fund compared to the benchmark. Funds with high beta will outperform the market heavily in the upcycle and vice versa. It can be a good option for very aggressive investors, but risk-averse investors should avoid such funds.