Note on Financial Ratios and Metrics for ETFs and Mutual Funds performance.

In the context of Exchange Traded Funds (ETFs) and Mutual Funds, various financial ratios and metrics are used to evaluate their performance, risk, and other attributes. Below, we provide brief explanations of each of these concepts:

1. Sharpe Ratio: The Sharpe Ratio is a measure of risk-adjusted return and is used to assess an investment’s return relative to its volatility or risk. It is calculated as the difference between the fund’s return (or excess return over a risk-free rate) and the risk-free rate divided by the fund’s standard deviation of returns. A higher Sharpe Ratio indicates a better risk-adjusted performance.

2. Sortino Ratio: The Sortino Ratio is like the Sharpe Ratio but focuses on downside risk. It measures the return relative to the downside volatility or downside risk of an investment, using the standard deviation of negative returns. The Sortino Ratio is considered a more suitable measure when assessing investments with asymmetric returns and is especially relevant for risk-averse investors. A higher Sortino Ratio is better  as it offers a better downside protection.

3. Alpha (α): Alpha measures the excess return of an investment relative to its expected return based on its level of risk (as indicated by its beta). A positive alpha suggests that the investment has outperformed the market (or benchmark) after accounting for its risk, while a negative alpha indicates underperformance. A higher Alfa is better.

4. Beta (β): Beta measures the sensitivity of an investment’s returns to the overall market movements (represented by a benchmark index), such as the SENSEX / NIFTY A beta of 1 indicates that the investment moves in line with the market, while a beta greater than 1 suggests higher volatility than the market, and a beta less than 1 indicates lower volatility.

5. R-Squared: R-Squared represents the proportion of a fund’s returns that can be explained by movements in the benchmark index. It provides an indication of how closely the fund’s performance aligns with the benchmark. An R-squared value of 1 indicates that the fund’s movements perfectly match the benchmark, while a value closer to 0 means the fund’s returns are not related to the benchmark.

6. Volatility / Standard Deviation: Volatility or Standard Deviation measures the dispersion of an investment’s returns from its average return. Higher volatility indicates greater price fluctuations and, consequently, higher risk so lower metrics is better. It is a key metric in assessing risk in both ETFs and mutual funds. A lower metrics is better.

7. Treynor Ratio: The Treynor Ratio is a risk-adjusted performance measure that evaluates an investment’s return in relation to its systematic risk (beta). It is calculated as the difference between the fund’s return and the risk-free rate divided by the fund’s beta. The Treynor Ratio helps investors assess the fund manager’s ability to generate returns relative to the level of market risk taken. A higher Treynor Ratio is better.

8. Tracking Error: Tracking Error measures the extent to which the returns of a fund deviate from its benchmark index. It provides an indication of the fund’s ability to replicate the performance of the index it aims to track. Lower tracking error indicates better tracking efficiency. A lower Tracking Error metrics is better.

9. Upside Capture Ratio: The Upside Capture Ratio measures how well a fund performs relative to its benchmark during positive market periods. It is calculated by dividing the fund’s return during up-market periods by the benchmark’s return during the same periods. A higher Upside Capture Ratio is better.

10. Downside Capture Ratio: The Downside Capture Ratio measures how well a fund performs relative to its benchmark during negative market periods. It is calculated by dividing the fund’s return during down-market periods by the benchmark’s return during the same periods. A lower Downside Capture Ratio metrics is better.

11. Expense Ratio: The Expense Ratio represents the annual cost of owning a fund and is expressed as a percentage of the fund’s total assets under management. It includes management fees, administrative costs, and other expenses. A lower expense ratio is generally preferable for investors, as it reduces the drag on returns. A lower Expense Ratio is better.

12. Dividend Yield: The Dividend Yield is the annual dividend income paid by the fund, expressed as a percentage of the fund’s current market price. It is especially relevant for income-seeking investors where higher yield is better.

13. Portfolio Turnover Ratio: The Portfolio Turnover Ratio measures the rate at which a fund’s holdings are bought and sold within a given period. A high turnover ratio indicates frequent buying and selling, potentially leading to higher transaction costs and tax implications.

14. Information Ratio: The Information Ratio assesses the risk-adjusted return of a fund relative to its benchmark. It is calculated as the difference between the fund’s excess return (above the risk-free rate) and the benchmark’s excess return divided by the fund’s tracking error. A higher information ratio indicates superior risk-adjusted performance.

15. Point to Point Return: The Point-to-Point Return measures the total return of an investment between two specific dates. It reflects the percentage change in the investment’s value over the selected period.

16. Rolling Return: The Rolling Return calculates the annualized returns of an investment over various overlapping periods. It helps investors assess the fund’s consistency of performance over time.

17. Omega Ratio: Essentially, Omega is the ratio of upside returns relative to downside returns. The higher the Omega value, the greater the probability that a given return will be achieved or exceeded. The ratio is an alternative to the widely used Sharpe ratio and is based on information the Sharpe ratio ignores. A higher Omega Ratio is better.

18. Calmar Ratio: The Calmar ratio is primarily used as a measure of risk-adjusted performance. A higher Calmar ratio indicates that an investment has produced higher returns relative to its maximum drawdown, which is generally desirable. A higher Calmar Ratio is better.

Conclusion: These financial ratios and metrics provide valuable insights into the performance, risk, and attributes of Exchange Traded Funds (ETFs) and Mutual Funds (MFs). Investors can use these metrics to make informed decisions about their investment choices based on their financial goals, risk tolerance, and investment time horizon.

: DISCLAIMER:

The published “MONEYSMART” note(s) in the current and subsequent series, is and shall purely be  for educational purpose only and the same must NOT be in any manner construed as Advice and / or recommendation for investment.”

Compiled By/-

Prakash Joshi

(Ex-Banker & Freelance Educator)

Mumbai – 400057.

E-Mail :- [email protected]