- 3 years ago
- How do you identify risk in your portfolio?
- Categorising mutual funds via their sharpe ratio
Alex Mathew speaks to Aditya Shah and Rohin Pagdiwala on 'The Mutual Fund Show'. #NDTVProfitLive
Guest List:
Rohin Pagdiwala,CFP & Founder Pagdiwala Investments
Aditya Shah, Founder, Hercules Advisors
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- Categorising mutual funds via their sharpe ratio
Alex Mathew speaks to Aditya Shah and Rohin Pagdiwala on 'The Mutual Fund Show'. #NDTVProfitLive
Guest List:
Rohin Pagdiwala,CFP & Founder Pagdiwala Investments
Aditya Shah, Founder, Hercules Advisors
_______________________________________________________
For more videos subscribe to our channel: https://www.youtube.com/@NDTVProfitIndia
Visit NDTV Profit for more news: https://www.ndtvprofit.com/
Don't enter the stock market unaware. Read all Research Reports here: https://www.ndtvprofit.com/research-reports
Follow NDTV Profit here
Twitter: https://twitter.com/NDTVProfitIndia , https://twitter.com/NDTVProfit
LinkedIn: https://www.linkedin.com/company/ndtvprofit
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TVTranscript
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03:34 Hi, thanks so much for joining in.
03:36 You're watching the Mutual Fund Show on NDTV Profit,
03:38 and my name is Alex Mathew.
03:40 This show gets you actionable insight on everything related
03:43 to mutual funds so that you can make informed decisions that
03:47 help you achieve the goals that you've set for yourself.
03:50 Now, ordinarily, the things that you
03:53 need to make that right decision is information.
03:57 And when you look at various platforms,
04:01 various organizations that give you that information,
04:06 one of the things that you will use
04:08 to determine which fund to invest in
04:11 is the performance of that fund over a period of time.
04:14 And invariably, I've found that investors
04:17 look at just the last 12 months.
04:19 But even if they look deeper and they look at the rolling
04:22 returns, say, over a five-year or a 10-year period,
04:25 that is not enough even there.
04:29 We're talking about a few metrics
04:31 that you will use beyond just the returns
04:35 that you will benefit from that will help you make
04:39 the right investment decision.
04:41 Those are the standard deviation as well as the beta as well
04:45 as the Sharpe ratio.
04:46 That might sound a little technical right now,
04:49 but we promise that we will break it down for you.
04:52 Join me on this program.
04:53 I've got Aditya Shah, the founder of Hercules Advisors,
04:55 and Rohin Pagdiwala, the CFP and founder
04:58 of Pagdiwala Investments.
05:00 Thank you so much, gentlemen, for taking the time.
05:02 Firstly, what metrics do you focus on?
05:06 Is it just these three?
05:07 Is there more?
05:08 How do you reach the decisions that you
05:10 make when you're choosing which fund to advise your clients?
05:13 Aditya, first to you.
05:15 So generally, when you choose a mutual fund,
05:17 as you correctly said, you should not just
05:19 be looking at the returns.
05:21 You should be looking at the risk-adjusted returns.
05:23 Returns is something that are visible.
05:25 Risk is something that is invisible
05:27 and that needs to be studied before you invest
05:30 in any mutual fund, per se.
05:31 So for us, these three metrics are really very important.
05:35 Together with the quality of the fund manager
05:37 and the track record of the fund manager,
05:40 these are the four things that we really
05:42 look closely before we start to invest in a mutual fund,
05:45 per se.
05:46 Strategy of the mutual fund together with this
05:48 is really very important that you need to really concentrate.
05:51 So these four metrics together with the fund manager
05:54 is the right formula for investing in any mutual fund.
05:57 OK.
05:58 So the idea is that you don't need
06:01 to calculate these yourselves.
06:03 That's not the objective of this particular program.
06:05 The objective is that once we're done,
06:07 or once these gentlemen are done explaining these concepts
06:11 to you, when you speak to your advisor,
06:13 or if you're a DIY investor, when you look at a fact sheet,
06:17 you will be able to look at the performance
06:19 of these metrics as well and drill down and narrow down
06:23 the options to suit your requirements.
06:25 So let's talk about the first concept,
06:27 which is standard deviation.
06:29 You've probably heard this in statistics class,
06:32 but how does it relate to mutual funds?
06:34 Rohan, I'll start with you.
06:36 Why do you look at standard deviation
06:38 when it comes to mutual funds?
06:40 So standard deviation is actually a very broad metric
06:43 used for a lot of data analysis.
06:46 In mutual funds, you use it to just measure volatility
06:48 of the fund's performance compared to a benchmark.
06:51 So ideally, you'd like a fund which is more predictable
06:55 in terms of returns, so the lower the standard deviation,
06:58 the better it is in terms of evaluating
07:00 that fund's suitability for your portfolio.
07:04 So yeah, standard deviation, I think,
07:06 is one of the more basic measures that you use
07:08 to measure the risk of the portfolio
07:10 when looked at from a volatility perspective.
07:12 To break it down even further, and if you were to talk
07:15 about a particular fund that has, say, given a 20% return
07:19 over a period of time, how would you explain standard deviation?
07:22 So a standard deviation, in layman's language,
07:24 would mean the number of times the fund has gone above
07:29 or below 20%.
07:30 So every year, the fund return would not have been 20%
07:33 if it was a three-year return.
07:35 Some years or some months, the returns would have been
07:38 above 20%, some years or some months,
07:40 the return would have been lower than 20%.
07:43 So the standard deviation measures what is the upper level
07:48 and the lower level of that variation per se.
07:51 Higher the variation, it means the fund is going
07:54 way above 20% or way below 20%.
07:57 Lower the deviation means the fund is very, very close
08:00 by to 20% per se.
08:02 So net-net, we want a fund which is very close by
08:05 to the returns that we are expecting,
08:07 so lower the standard deviation, the better is it
08:09 for a mutual fund.
08:10 But it's not enough to look at just this metric
08:13 because perhaps just looking at this one metric
08:16 will throw you off.
08:17 Why is that?
08:19 Yeah, so this is, like I was saying, this is a measure
08:22 of risk, right?
08:23 It's a measure of risk.
08:24 Volatility.
08:25 And through volatility, right?
08:26 There are several other ways to look at risk.
08:29 And in a fund's performance evaluation, you look at
08:32 not just risk, but you look at various other parameters
08:34 like Aditya was alluding to earlier.
08:36 You look at the AMC's process, you look at the fund managers,
08:39 track record, you will look at returns, of course,
08:41 which is the most common metric that most investors
08:44 will look at.
08:45 So there are other ratios, for example, the Sharpe ratio,
08:48 which is the most widely used.
08:50 There is a beta that you would look at.
08:52 So let's get into that.
08:53 Aditya, beta, how do you explain it?
08:56 And I think to a certain extent, this will govern
09:00 how a fund performs vis-a-vis a benchmark, right?
09:03 Yes.
09:04 So standard deviation is just an ingredient to calculate
09:07 the other two measures.
09:09 One of the most important measures is beta.
09:11 So what is beta actually?
09:12 Beta is with respect to a benchmark.
09:14 So for example, for large-cap mutual funds,
09:17 the benchmark is a Nifty 50 index.
09:19 So the volatility of Nifty 50 index over a period of time
09:22 is measured, and your fund's volatility with respect
09:26 to that index is then encapsulated by beta.
09:30 There's a beta value of 1 for the index,
09:35 and with respect to that index, how much up and down
09:38 we are moving, we are calculating that by beta.
09:41 So for example, if your fund has a beta of 1.2,
09:44 it means that if the index moves by 10%,
09:48 your fund will move by 12%.
09:51 Higher the beta for a fund, it means higher the movement
09:56 it will show with respect to the index movement, right?
10:00 So that's the broad meaning of beta,
10:03 that the movement of your fund with respect to a 10% movement
10:07 in the index.
10:09 Understood.
10:10 So therefore, and I would think that you will have
10:13 different pockets of mutual fund schemes
10:17 that will have different readings on this,
10:21 and it will be okay to have a beta of a certain range.
10:24 I would think, of course, index funds would track the index exactly,
10:29 and so the beta would be 1 there.
10:31 But if you're talking about large caps,
10:33 because the variance on the performance is not very wide,
10:37 apart from 2023, you will have the beta that is not
10:41 very significantly higher than 1, right?
10:43 That's right.
10:44 But then what ranges would be okay for mid-cap and small-cap
10:47 and the various other categories?
10:49 So in general, the higher the beta,
10:53 I mean, it depends on the objective of the investor.
10:57 If you want to capture, for example, momentum in a rally
11:00 in stocks, then you want to go for high beta products,
11:03 whether it's equity or in mutual funds.
11:07 I mean, best examples would be, let's say,
11:09 manufacturing funds or very thematic funds,
11:11 which are currently into, let's say,
11:13 pharma sector--not pharma, sorry,
11:15 into infrastructure sector or capital goods,
11:17 funds which are heavily invested in those stocks
11:21 will typically have high beta because these are cyclical stocks
11:23 and cyclical funds, therefore.
11:26 So it depends on your investor's objective.
11:28 If you want to remain close to the index,
11:30 then you're better off going with diversified funds.
11:33 Of course, in that category, also small-caps will have
11:35 a higher beta compared to mid-caps,
11:37 and mid-caps will typically have a higher beta
11:38 compared to large-caps.
11:40 Because the index itself is--it also depends on the benchmark
11:43 that you've chosen.
11:44 If you've chosen the Nifty, then obviously the large-cap
11:46 will have a close correlation with the Nifty.
11:48 Does that also work on the downside?
11:49 It obviously does, right?
11:51 So therefore, if you have a higher beta,
11:52 you should be okay with losing more on the downside.
11:56 So beta works both ways.
11:58 Beta can have a value higher than 1 or lower than 1 as well.
12:01 It really depends on the type of fund that you are choosing.
12:05 There will be a high variance on the small-cap mutual fund side of it.
12:10 We have seen betas ranging from 0.8% to 1.2%, 1.3%,
12:15 depending on the strategy that a fund manager wants to adopt.
12:18 Let me take an example.
12:19 Quant, during its inception years, had a very momentum type of a strategy
12:23 where they wanted to chase momentum.
12:25 And because of that, their beta was very, very different
12:29 from all other small-cap mutual funds.
12:31 Their beta was 1.2%, 1.3%, 1.4% at a certain point in time.
12:36 So it really depends on what the fund manager's strategy is.
12:40 Those who are chasing that strategy, they clearly knew
12:43 that they are chasing momentum.
12:44 And because they are chasing momentum, that is the price of risk
12:47 that they will need to really pay.
12:49 So you need to really concentrate on what the fund manager's strategy is
12:53 and then align it with the beta per se.
12:56 But for a normal retail investor, a too high beta on the entire portfolio
13:02 is not something that we would really like to see.
13:05 Understood. Alright.
13:06 So we have discussed standard deviation, we have discussed beta.
13:09 You have kind of got a sense of how these two metrics work.
13:12 So when you see a fact sheet, you will be able to judge
13:15 depending on, of course, which category this mutual fund scheme is,
13:19 whether or not this is going to work for you.
13:21 In conjunction, as these two gentlemen have pointed out,
13:25 with certain other factors, including, but not limited to,
13:29 the returns over a period of time, that is the performance of the fund,
13:33 as well as the objective and the approach of the fund itself
13:39 and the fund manager.
13:40 So we will talk about one more ratio at the very least.
13:43 We might be able to slip in a few more.
13:46 One is the Sharpe ratio.
13:47 If we have time, we will also talk about the Sortino ratio.
13:50 But we have to slip into a very quick break.
13:52 Do stay tuned.
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16:04 Welcome back.
16:05 You are watching the Mutual Fund Show.
16:07 And we are discussing risk metrics that will help you make the right financial decision
16:12 when you are buying mutual funds or investing in mutual funds.
16:16 And we have reached the point where we are going to discuss the Sharpe ratio.
16:21 Aditya, I will come to you first.
16:23 And I am pretty sure that I am going to ask multiple questions about this
16:26 because this is a little more complicated to explain, I would think,
16:29 than standard deviation and beta which we have already discussed.
16:33 How does this get calculated and what does it indicate?
16:36 So, I think this is one of the easiest metrics to explain.
16:40 Okay.
16:41 Simply put, it is a return that a mutual fund makes per unit of risk that the mutual fund is taking.
16:47 Okay.
16:48 Very simply. Risk is how much you got. That is called the Sharpe ratio.
16:53 Okay.
16:54 You must look at this ratio rather than looking at the return side of it
16:58 because this ratio encapsulates the risk as well in your portfolio.
17:02 Okay.
17:03 Now, this higher the Sharpe ratio, the better it is.
17:07 Why is it better?
17:08 It is better because for every unit of risk that the mutual fund has taken,
17:12 the mutual fund is able to deliver a better return than all other mutual funds.
17:17 Let me give you an example.
17:18 Before you do that, how do you define risk in this situation?
17:21 So, in the formula, the standard deviation goes into the calculation of Sharpe ratio.
17:30 So, as I said in the beginning, standard deviation is the recipe for calculating all the other metrics.
17:36 Sure.
17:37 It is a very, very important metric.
17:39 Per se, you don't need to worry about it, but all other ratios get calculated by the standard deviation.
17:46 So, now your illustration.
17:47 Yeah. So, my illustration is if there are two funds where on one fund the return is 15% and on the other the return is 12%,
17:56 however, the Sharpe ratio on the fund A with a higher return is 0.9% and on the other one it is 1.12%.
18:05 Even though fund B has given a lower return per se in absolute terms, fund B is a better fund
18:11 because for every unit of risk that the fund B has taken, it has generated a higher return per se.
18:18 So, our eye tells us something which is very different.
18:22 Quantitative factors will tell you something which is very different.
18:26 So, always and always look at the Sharpe ratio when you are investing.
18:30 This is easily available in all the fact sheets.
18:33 Higher the Sharpe ratio, the better it is, the better delivery of returns a mutual fund manager is really doing for you.
18:40 So, let me try and understand this also from the perspective, Rohin, over the last year.
18:46 You've had a lot of money flow into small cap and mid cap and I've heard people express disappointment
18:54 if their fund or the scheme that they have invested in, in either the mid cap or the small cap category,
19:00 has returned say a 35% and the rest of their peers or maybe their neighbor's fund has done a 47%.
19:08 So, the gap is about 10 percentage points.
19:11 But then in that situation, if the 35% returning fund has a higher Sharpe ratio than the fund that was given 47%,
19:20 then I am still better off or that person that was saying they are disappointed is still better off.
19:26 Is that how you read it?
19:27 See, in hindsight, obviously the person who's got the higher return is better off.
19:32 Fundamentally speaking, he made the money.
19:34 But if you were to today look at investing, I would agree with what Aditya is saying is that
19:39 the Sharpe ratio should be one of your key decision metrics in choosing the fund.
19:44 So, in case of let's say people investing into small cap funds, again,
19:48 and I would tie this down to what objective they came in with.
19:51 If they want to ride the momentum that's in the market and they want to capture opportunities,
19:55 then maybe a Sharpe ratio, which also ideally should be measured over a longer period of time,
20:00 is something that should be looked at but may not be the primary driver of choosing the fund.
20:06 So, you want to, in this case, from a risk point of view, of course,
20:12 35% fund which gave 35% returns has a better Sharpe ratio and therefore is a better choice to be made in the future.
20:18 Yes.
20:19 But the fact is that the guy who already made 47% return is the one who's…
20:23 So, because and here's where we're talking about and I think this is in a standard disclaimer
20:28 on every mutual fund ad that you see as well, your past performance is no guarantee of future returns.
20:34 And because you're making your decisions expecting a certain performance, right?
20:40 You cannot be guaranteed anything going forward.
20:43 So, you have to judge the risk that is involved in taking that decision.
20:48 So, essentially what we're trying to do is measure the risk and the potential return
20:53 if I'm taking less risk and getting a certain return I should be, is that the way to look at it Aditya?
20:58 Yes.
20:59 So, I just want to give a disclaimer to every investor today.
21:03 Investors have been spoiled over the last one, one and a half, two years
21:07 where the returns have been spectacular, especially in the last one year on the small cap side of it.
21:11 As you said, somebody is not even happy with 35% return.
21:15 The perspective today is one needs to be very disciplined in their investment strategies.
21:21 One needs to not blindly chase small cap funds.
21:25 These metrics, if I were an advisor, I would tell them, of course, you have made a lesser absolute return per se,
21:34 but the quality of those returns are really very good and you need to stick to this fund manager per se
21:39 because when the down cycle really comes, this fund manager is going to outperform the other fund manager
21:45 who has gotten the higher return per se.
21:47 The protection of the downside.
21:48 The protection of the downside, which is the risk.
21:50 As I keep saying, return is something which is visible,
21:53 risk is something which is invisible to average retail investor per se.
21:57 So, a pure play, the 35% return, the quality of the return is very, very good
22:03 and that's what the investors need to really concentrate on.
22:06 The whole objective of this show is to quantify to people at times when the markets are euphoric,
22:12 don't just get blindly chase returns.
22:15 Try to understand about the risk that comes associated with your investments.
22:21 Again, the last disclaimer I want to give in 2017, 18, 19,
22:26 there were times when small cap funds were down 30, 40, 50%
22:30 and just because we have gotten spectacular returns over the last one, one and a half, two years
22:35 does not mean that they will repeat over the next one or two years.
22:39 But from your end, you can be very disciplined and you can be very consistent
22:44 and you can do all these things correctly as we have told you,
22:47 so that your investments are protected.
22:49 So, let's look at a few illustrations as well because that I think ultimately
22:53 is going to help our viewers make the right choice and the right decision.
22:57 I will come to you Rohin in just a bit because you've got recommendations based
23:01 or you've looked at a list of schemes that you like based on these risk metrics.
23:06 You've also captured some of these metrics in large cap, small cap and mid cap, right?
23:13 And you've looked at flexi cap and multi cap.
23:15 So, I think we've got a pretty wide list.
23:18 What can you tell us about the schemes that you have identified?
23:21 So, the schemes that we have identified across large, mid and small cap,
23:25 we've tried to look at basically the Sharpe ratio
23:29 because Sharpe ratio encapsulates the standard deviation.
23:33 Sharpe ratio also tries to encapsulate the risk that is there.
23:37 And if you will see on the screen, you will find all the large, mid and small cap
23:43 recommendations as we have already given the mid cap recommendations that you are seeing.
23:49 You can already see in the PGI fund, the Sharpe ratio is higher than one.
23:54 So, basically what this means is for every unit of risk, a PGI fund is able to deliver 1.01% of return per sale.
24:03 So, all of these funds are really very good funds.
24:06 You need to stick to these funds during times of up cycle and down cycle.
24:11 We've recommended across the large, mid and the small cap.
24:14 Why don't you talk about the ones that you've selected?
24:17 Is it only on the basis of Sharpe or have you also…
24:20 I've looked at a combination of Sharpe ratio, standard deviation, even to some extent Sortino,
24:26 which is a sort of an evolution from Sharpe ratio.
24:29 But primarily in the multi-cap or the flexi-cap category, you get an HDFC retirement fund,
24:34 a JM flexi-cap, a Mahindra focused, etc.
24:37 Because all of these funds have a reasonable amount of return at a lower standard deviation and a lower risk unit.
24:45 One notable exception is a Quan flexi-cap, which is high on returns,
24:49 but it has got a very high standard deviation.
24:51 And therefore, it's excluded from that list of funds that you would invest in, especially at this point of time.
24:56 Of course, if an investor comes to me and says, "Listen, I'm okay. I can stomach the risk,"
25:00 then by all means, you can look at a high standard deviation fund as well.
25:04 Fantastic. All right. So, hopefully, we've cleared some doubts and we've addressed some issues
25:09 that people might have in this election.
25:11 Gentlemen, thank you so much for joining in and for speaking to us on NDTV Profit.
25:15 And viewers, by the way, of course, we've dealt with a few technical aspects on this particular show,
25:20 but the objective was to help you make the right financial decision.
25:23 If you've got specific questions on anything that we've discussed on this program,
25:27 you can write to us on any one of our social media platforms.
25:30 In the meanwhile, there's lots more coming up over the course of the day.
25:33 And do stay tuned. This is NDTV Profit.
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