Beta In Mutual Funds- What Is Beta For Mutual Funds
Let us start with a small riddle. You have a choice of two funds. Fund A has given 14% annualized returns over the last 3 years and each year the returns have been in the range of 12% to 15%. Then there is Fund B that has given 16% annualized returns over the last 3 years. However, its returns in the last 3 years have ranged from negative returns to high positive returns.
Which fund would you prefer? There is no rocket science in guessing the answer. You will prefer Fund A. But are you not getting higher returns on Fund B? That is true but it comes with a lot of volatility in returns. In other words, the Fund B is not consistent. When a fund is consistent, you are confident that irrespective of when you enter the fund, you can still get decent returns. This is very important for long term investors.
In other words what you are saying is that Fund B is riskier than Fund A because the returns of Fund B are more volatile and wavering up and down compared to Fund A. But how do we measure risk. There are various approaches to measuring risk of a fund like Standard Deviation, Sharpe Ratio, Treynor Ratio and Beta. Here we will focus purely on Beta as a measure of risk.
What Exactly Does Beta Tell Me?
Let is start with the beta of a stock. Beta of a stock is a measure of how volatile a stock with reference to the index like Nifty or Sensex. For example based on beta, a stock is classified into 3 categories.
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Aggressive stocks have a Beta of more than 1. Such stocks move more than the index both on the upside and on the downside. For example if a stock has a Beta of 1.2, then a 1% rise in the Nifty will result in a 1.2% rise in the stock and a 1% fall in the Nifty will result in 1.2% fall in the specific stock.
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Neutral stocks have a Beta of around 1 (typically Beta between 0.97 and 1.03). Such stocks move at par with the index both on the upside and on the downside. For example if a stock has a Beta of 0.99, then a 1% rise in the Nifty will result in almost a similar rise in the stock and a 1% fall in the Nifty will result in an almost similar fall in the specific stock.
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Defensive stocks have a Beta of less than 1. Such stocks move less than the index both on the upside and on the downside. For example if a stock has a Beta of 0.85, then a 1% rise in the Nifty will result in a 0.85% rise in the stock and a 1% fall in the Nifty will result in 0.85% fall in the specific stock.
Normally, the rule is that higher the Beta, higher is the risk in the stock.
Now, Can You Tell Me What Is The Beta Of An Equity Mutual Fund?
The Beta of an equity mutual fund is the weighted average of the betas of the stocks held by them. Here is how the betas of a mutual fund with 5 stocks is calculated.
| Stock in the portfolio | Portfolio Value (Rs cr) | Value Weightage | Beta | Weighted Beta |
| Reliance | 85.33 | 0.2975 | 1.15 | 0.34 |
| Infosys | 70.44 | 0.2456 | 1.12 | 0.28 |
| ICICI Bank | 53.12 | 0.1852 | 0.85 | 0.16 |
| HDFC Bank | 21.95 | 0.0765 | 0.91 | 0.07 |
| Bharti Airtel | 55.96 | 0.1951 | 1.02 | 0.20 |
| 286.80 | 1.04 |
In the above illustration, the weighted average beta of all the stocks in the portfolio is the beta of the mutual fund. In the above case, the beta of the above fund is 1.04, which almost makes it a market neutral portfolio that will almost move in tandem with the Nifty index.
How Is Beta Of Mutual Funds Helpful?
There are several advantages to studying the beta of a mutual fund. Here are a few of them captured.
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Beta is a measure of risk. Returns are just one side of the investment coin and risk is the other side. You can look at returns in isolation.
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Beta measures the sensitivity of the mutual funds to shifts in the index, so based on index volatility you can take a call on whether to stay in the fund or not.
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Beta can also act as a good predictor of fund's price movement or NAV movement as well as its volatility.
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Beta evaluates investment risk and helps an investor to judge a fund's performance based on the risk factor. Measures like Treynor are based on Beta.
Beta Is The Risk That Cannot Be Diversified Away
This is the most important thing to know. One of the important tasks of a fund manager is to diversify or spread risk. If RIL is doing well and Infosys is doing well then the overall risk of the portfolio gets neutralized. That is diversification. Broadly, there are 2 types of risk. Unsystematic risks like industry cycles, competition, pricing pressures can be diversified and a fund manager is expected to do that.
However, there are factors like FII outflows or rupee weakness or inflation or interest rates which impact all the stock uniformly. That is systematic risk and that is what cannot be diversified away. For fund managers, Beta measures the risk they cannot be reduced.