How mutual funds performed on risk adjusted returns?

25 Nov 2024 , 11:13 AM

WHY RISK ADJUSTED RETURNS

An interesting way to look at the performance of funds over a longer period of time is the risk adjusted returns. Two similar fund earning similar returns may be very different if you look at the level of risk. For instance, a fund that generated 13% returns with 12% standard deviation is substantially better than a fund that generated 14% returns with 25% standard deviation. That is where risk adjusted returns come in handy. Here we look at the risk adjusted returns based on the various fund categories, to understand which categories are scoring on risk adjusted returns. But, how have we gone about the risk-adjusted returns?

We have used the average returns of the particular category as the benchmark return for the category. For the risk measure we use range instead of standard deviation as it is simpler and prone to less assumptions. The range in this case for any category would be the difference between the highest return and the lowest return in that category. That is a fair measure of volatility and risk. When the average returns are divided by this range factor, we get the risk-adjusted returns. It is on this risk adjusted returns that each of the categories of funds are ranked. Here, the risk-adjusted return does not mean much in isolation. What it does tell us is how they rank vis-à-vis others over a 10-year period.

CAPITALIZATION FUNDS: RANKING ON RISK ADJUSTED RETURNS

Here we rank the various fund capitalization categories on risk adjusted returns as of November 2024. These returns pertain to a 10-year period CAGR returns.

Active Equity Funds – MCAP	Average	Best	Worst	Range	Risk-Adj Returns
Multi-Cap	15.39	19.25	13.09	6.16	2.4984
Large-Cap	11.96	14.79	9.09	5.70	2.0982
Mid-Cap	16.86	21.66	13.37	8.29	2.0338
Small-Cap	18.38	23.37	14.14	9.23	1.9913
Large & Mid- Cap	14.75	19.19	10.07	9.12	1.6173
Flexi Cap	13.39	19.39	8.63	10.76	1.2444

Data Source : Morningstar

What do we read from the categorization above. Among the various capitalization categories, it is the multi-cap fund that have done really well. Ironically, while flexi-caps are found right at the bottom. Goes to show that more fund manager discretion has added to the risk and volatility without adding proportionately to the returns. Not surprisingly, large caps rank above mid-caps and small caps. While they have earned lower average returns, they have scored on lower volatility risk. Discretion literally ranks at the bottom of the list.

EQUITY THEMATIC FUNDS: RANKING ON RISK ADJUSTED RETURNS

Here we rank the various fund thematic categories on risk adjusted returns as of November 2024. These returns pertain to a 10-year period CAGR returns.

Active Equity Funds – Thematic	Average	Best	Worst	Range	Risk-Adj Returns
Equity – ESG	12.83	13.26	12.40	0.86	14.9186
Sector – FMCG	12.88	13.14	11.64	1.50	8.5867
Sector – Technology	17.87	19.44	15.05	4.39	4.0706
Sector – Healthcare	14.58	16.73	12.69	4.04	3.6089
Dividend Yield	13.91	15.99	11.72	4.27	3.2576
Value	14.77	18.13	12.17	5.96	2.4782
Contra	15.15	17.84	11.37	6.47	2.3416
Focused Fund	13.54	17.03	10.54	6.49	2.0863
Equity- Infrastructure	15.37	18.99	10.44	8.55	1.7977
Sector – Financial Services	10.88	16.06	9.84	6.22	1.7492
ELSS (Tax Savings)	13.74	21.95	9.67	12.28	1.1189

Data Source : Morningstar

Incidentally, the top ranked funds are not there due to higher returns but due to lower volatility risk. For instance, ESG Fund are fairly structured and hence the volatility is very low. The case is the same with FMCG funds also where the gains of low risk are very evident. Technology also figures at the top, but here it is the contribution of returns that is more prominent. At the bottom of the heap, you have ELSS funds, Financial services fund, and infrastructure funds where the risk volatility risk levels are inordinately high. The crown goes to the theme that manages it volatility risk better than the others.

HYBRID ALLOCATION FUNDS: RANKING ON RISK ADJUSTED RETURNS

Here we rank the various fund hybrid allocation categories on risk adjusted returns as of November 2024. These returns pertain to a 10-year period CAGR returns.

Hybrid Allocation Funds	Average	Best	Worst	Range	Risk-Adj Returns
Balanced Allocation	9.09	10.32	8.02	2.30	3.9522
Equity Savings	8.43	10.69	5.61	5.08	1.6594
Dynamic Asset Allocation	9.56	14.23	6.85	7.38	1.2954
Aggressive Allocation	12.09	17.13	7.03	10.10	1.1970
Conservative Allocation	7.10	10.89	3.87	7.02	1.0114

Data Source : Morningstar

What are the key takeaways from the ranking of the hybrid funds. Here discretionary funds appear to have don fairly well. At the top is the balanced allocation fund, which looks at a rule based allocation to equity and debt. Ironically, both the conservative and the aggressive hybrid fund are at the bottom. What ranks higher is the hybrid funds that mix their asset classes across a diversified low-correlation base. That is where the equity savings fund and the Balanced advantage Funds (BAFs) are scoring brownie points.

ACTIVE DEBT FUNDS: RANKING ON RISK ADJUSTED RETURNS

Here we rank the various active debt fund categories on risk adjusted returns as of November 2024. These returns pertain to a 10-year period CAGR returns.

Active Debt Funds	Average	Best	Worst	Range	Risk-Adj Returns
Long Duration	6.57	8.18	5.63	2.55	2.5765
10 yr Government Bond	6.83	8.62	5.43	3.19	2.1411
Floating Rate	6.43	8.34	4.94	3.40	1.8912
Medium to Long Duration	6.04	8.38	4.03	4.35	1.3885
Money Market	5.72	7.80	3.52	4.28	1.3364
Corporate Bond	6.40	9.12	3.78	5.34	1.1985
Ultra Short Duration	5.49	7.84	3.04	4.80	1.1438
Short Duration	6.13	9.17	3.74	5.43	1.1289
Low Duration	5.67	7.87	2.11	5.76	0.9844
Government Bond	6.86	9.09	2.12	6.97	0.9842
Credit Risk	6.11	8.65	2.39	6.26	0.9760
Medium Duration	6.19	9.16	2.46	6.70	0.9239
Dynamic Bond	6.52	10.16	3.02	7.14	0.9132
Banking & PSU	6.27	8.46	0.00	8.46	0.7411

Data Source : Morningstar

You will find that the range of returns is quite narrow with respect to the different category of debt funds. Where these funds differ is on the volatility risk undertaken. For example, if you look at the top, there are the long duration funds, 10-year G-Sec Bond Fund, Floating Rate fund etc. These categories of funds have been profitable for investors despite giving sub-par returns as a category. The reason is the buy and hold strategy allows them the benefit of keeping risk levels low. In fact, more the discretion given to the fund managers, greater is the volatility risk generated and hence lower the risk adjusted returns.

ALTERNATE FUNDS: RANKING ON RISK ADJUSTED RETURNS

Here we rank the various alternate fund categories on risk adjusted returns as of November 2024. These returns pertain to a 10-year period CAGR returns.

Alternate Funds	Average	Best	Worst	Range	Risk-Adj Returns
Sector – Precious Metals	10.09	10.34	9.36	0.98	10.2959
Arbitrage Fund	5.91	8.68	4.54	4.14	1.4275
Liquid	5.18	6.75	0.00	6.75	0.7674

Data Source : Morningstar

We have considered 3 categories of fund here viz. precious metals, arbitrage funds, and liquid funds. As has been the experience in the past, it is the precious metals funds that hav outperformed this time too. Gold scores high on returns and also on risk, making it the pick among the alternate category of funds.

The risk-adjusted returns is a good measure of how reliable a particular strategy is. The trick of maintaining a good risk-adjusted return on a particular fund category is not to chase returns, but focus on keeping risk under control. If that can be managed, then even mediocre returns get magnified in reality. Low volatility, limited discretion to fund managers, and a rule-based approach to investing appears to be working favourably.