Assuming no material change in the fund and/or underlying holdings’ characteristics, one can assume that Fund 1 will likely be a more volatile investment than Fund 2. In debt funds, Gilt funds and Income funds have higher volatility (by extension, higher standard deviation) than Liquid funds. In other words, it is a measure of how much deviation occurs from the expected return of the instrument in question. The words volatility and standard deviation are used interchangeably. The higher the standard deviation, the greater the fluctuation is.

This deviation is a crucial ratio typically utilised by fund managers that benefit investors. To better assist you in evaluating risk, let’s explore the standard deviation. This deviation makes sense when comparing funds from the same category and asset class. The comparison will have greater meaning if the time period is likewise the same.

Equity schemes have a higher standard deviation in comparison to debt schemes. SD measures the dispersion or spread of a fund’s returns around its average return over a certain period of time. In simple terms, a greater standard deviation indicates higher volatility, which means the mutual fund’s performance fluctuated high above the average but also significantly below it. Therefore many investors use the terms volatility and standard deviation interchangeably. If you’ve done extensive research when analyzing mutual funds, you may have run across a statistical analysis term called standard deviation (not to be confused with downside deviation). The term may sound complex and perhaps beyond the comprehension of anyone other than a math or finance major, but using standard deviation with mutual funds can be simple and useful.

Risk disclosures on derivatives –

1. The SD of India domiciled mutual funds is computed based on the monthly returns for the past 3 years (as prescribed by AMFI) using the above denoted formula.
2. Alpha indicates how much value has been either added or subtracted by the fund manager’s investment call and Beta on the other hand marks how sensitive a fund can be to market movement.
3. Mean deviation tells us how far, on average, all values are from the middle.
4. Because if S&P Sensex 500 falls by  1%, then Tata Multicap fund is expected to fall by only 0.65% and not 0.95%.

While choosing a fund going by the standard deviation definition you may use standard deviation as a measure of risk assessment in alignment with your own risk appetite and investment time frame. For example if fund A’s risk appetite is higher than fund B’s choose the one that is in agreement with your risk appetite. The SD of India domiciled mutual funds is computed based on the monthly returns for the past 3 years (as prescribed by AMFI) using the above denoted formula. Simply averaging out the standard deviations, is no answer to understanding the market volatility of the portfolio.

The inherent risk in a mutual fund is revealed by the standard deviation. In an ideal world, investments would move in a smooth path in an upward direction, perfectly in line with the market conditions. But this is not the case in reality – the fluctuations might be rather stark and erratic. Though often less volatile than stocks, mutual funds are no exception to volatile, erratic behaviour. Standard deviation is one such measure that helps trace the behaviour of an investment with fluctuations and changes in the market over time. As you can see the 1st mutual fund is more in line with the category and index performance while the second has a higher standard deviation implying higher volatility.

What is market volatility?

Your go-to guide to creating amazing and easily understood investment content.Her forte lies in investment advisory and strategy with expertise in fundamental analysis and research. The higher it is, the more volatile the performance; both, the upside potential and risk of drawdowns is higher. Though it provides insight into the volatility of a particular mutual fund, there are some limitations of using Standard deviation. If the portfolio has several funds, then standard deviation cannot provide any comparable results. Consistency is good, but it’s not the only measure of a fund’s quality.

2 – Alpha

These outer bands oscillate with the moving average according to changes in price. Every value is expressed as a percentage, making it easier to compare the relative volatility of several mutual funds. Compared to debt plans, equity schemes have a higher standard deviation.

This can be mapped to your own risk appetite in order to decide if a fund works for you or not. As you can see in the table below, the Standard Deviation of equity funds is higher as compared to debt funds. Within debt funds, the SD of Liquid Fund will be lower in comparison to Dynamic Bond Fund which takes duration bet, or Gilt Fund which is susceptible to interest rate risk. To conclude, alpha is the excess return of the fund over above the benchmark returns.

Furthermore, all the monthly standard deviation values are annualised and represented as a percentage. For a mutual fund, it shows how far the returns deviate from the expected returns based on its past performance. From an asset class lens, equity exhibits higher volatility than fixed-income and commodities, albeit the potential upside too is higher. Well-diversified portfolios reduce the portfolio risk as they invest into diverse asset-classes/securities which respond differently to the same set of economic drivers. This cushions the portfolio against the underperformance of some of its constituents and provides a stable investment journey for the investor. Beta, on the other hand, is used to quantify the fund’s response to market volatility.

It is used to measure the distribution of the actual return from the mutual fund’s expected annual return. The square of each of these numbers must be added and the result must be divided by the total number of data points minus 1. Volatility refers to the extent to which a fund’s net asset value (NAV) fluctuates over a period of time.

This is because the returns of a fund vary every day depending on a variety of factors. In contrast, the returns on a bank fixed deposit are fixed and certain so there is no question of variability in returns. Another potential drawback of relying on standard deviation is that it assumes a bell-shaped distribution of data values. This means the equation indicates that the same probability exists for achieving values above the mean or below the mean. Many portfolios do not display this tendency, and hedge funds especially tend to be skewed in one direction or another. In investing, standard deviations are generally demonstrated with the use of Bollinger bands.

Hence looking at these ratios in conjunction with each other provides you with a broader picture and helps you make a more informed decision. The more securities held in a portfolio, and the more variety of types of securities, the less each individual security and its standard deviation matter to the whole portfolio. Now, instead of 34% standard deviation, assume Fund B’s standard Deviation is 18%. It bundles the concept of risk, reward, and the risk-free rate and gives us a perspective. Well, Fund B has a higher return, so without a doubt, Fund B is a better fund.

This will help you not just in your MF investments, but also investments in stocks. Alpha is defined as the excess return of the mutual fund over the benchmark return, on a risk-adjusted basis. Likewise, while beta gives us a perspective of the relative riskiness of an asset, it does not give us the absolute or the inherent risk of the asset itself. This is what I mean by ‘relative risk’; it gives us a perspective of how risky the fund is compared to its benchmark. But Fund 1 has a higher SD as the dispersion of returns from the fund’s mean is much greater than that for Fund 2.

Because if S&P Sensex 500 falls by  1%, then Tata Multicap fund is expected to fall by only 0.65% and not 0.95%. One of the what is standard deviation in mutual fund key attributes of the mutual fund is the ‘beta’ of the fund. The beta of a mutual fund is the measure of relative risk, expressed as number; Beta can take any value above or below zero. Beta gives us a perspective of the relative risk of the mutual fund vis a vis its benchmark.

For example, if the benchmark falls by 1%, the fund is expected to fall by 1%. So both the benchmark and the fund are expected to have similar risk profiles. Though SD is an indicator of the volatility of returns, it does not measure investment risk as most investors perceive it. Positive returns impact volatility in a similar manner as negative returns. As a result, SD punishes volatility in performance even though on the positive side. It seems odd that positive returns, could make a fund riskier, but that’s exactly the effect that they have.