Commonly used approaches to assess risks of mutual funds include the standard deviation, beta and Sharpe ratio.
1. Standard Deviation
Standard Deviation measures the variability of a population of performance data and shows how much variation or dispersion from the average. A low standard deviation indicates that the data points tend to be very close to the mean and as such lower risk; a high standard deviation on the other hand indicates higher variation and higher risk.
1. Beta (β)
The beta (β) of a stock or portfolio is a number describing the correlated volatility of an asset in relation to the volatility of the benchmark that the asset is being compared to. It measures the systemic risk that cannot be diversified away. A beta of 1 indicates that the security's price will move with the market. Beta less (greater) than 1 means that the security will be less (more) volatile than the market. R-squared is often used along with the beta number. R-squared values range from 0 to 100. An R-squared of 100 means that all movements of a security are completely explained by movements in the index. A higher R-squared value (between 85 and 100) indicates a more useful beta figure.
2. Sharpe Ratio
Sharpe ratio measures risk-adjusted performance and is the return achieved per unit of risk taken. The Sharpe ratio tells us whether a portfolio's returns are due to smart investment decisions or a result of excess risk. This measurement is very useful because although one portfolio or fund can reap higher returns than its peers, it is only a good investment if those higher returns do not come with too much additional risk. The greater a portfolio's Sharpe ratio, the better its risk-adjusted performance has been.
Sharpe Ratio = (Expected Return – Risk-Free Rate) ÷ Standard Deviation
3. Sortino Ratio
Sortino Ratio is similar to Sharpe ratio that measures the risk-adjusted return of an investment but penalizes only those returns falling below a user-specified target (downside risk). An intuitive way to view downside risk is the annualized standard deviation of returns below the target.
Sortino Ratio =(Expected Return – Risk-Free Rate) ÷ Downside Variance
Most hedge funds aim for absolute returns and unlike traditional funds where there are benchmarks to compare to. Therefore, risk measures, such as the Sharpe ratio, that are applicable to traditional funds are not s to hedge funds, but instead Sortino ratio should be used.
iFund investment product risk rating is a qualitative and quantitative assessment of a single fund’s geographic and asset class focus, investment style and potential risk factors. At the conclusion of the due diligence, each investment product is classified according to the preset asset classification and risk rating scores, ranking from 1 to 6 (1 is the lowest risk, 6 is the most risky).
General Risk-Return Spectrum for Mutual Funds: