Alpha and Beta in Mutual Funds & How It Is Calculated

The only way you can make a sound and informed investment decision is by examining your mutual fund options thoroughly regarding their profitability. While this typically requires you to study the mutual fund’s investment objective, fund manager’s experience, expense ratio, fund history, and the like, you can also support your decision-making with investment instruments such as Alpha and Beta.

These are tools that allow you to measure a mutual fund’s performance, its relationship to the market, and its response to market changes. Here we discuss everything from what these are to how these are calculated.

What is Alpha in Mutual Fund?

Alpha is a parameter that allows you to understand a mutual fund’s performance. It compares a mutual fund against an index, and if its calculated returns are above the index within a specific timeframe, the mutual fund is considered to be a good investment option. In case the value is 0, the mutual fund is believed to earn the same returns as the index. Below 0, it is considered to be an unfavourable investment option due to low returns.

What is Beta in Mutual Fund?

Beta is a metric that helps you ascertain the fund’s reaction to market fluctuations. It measures the sensitivity of the mutual fund. In mutual funds, Beta’s baseline is 1. If the mutual fund’s Beta is greater than 1, it's considered to be more volatile than the benchmark index. If it's equal to 1, it shares the same variation as the benchmark index. Lastly, if it is less than 1, the mutual fund is less reactive to changes than the benchmark index.

How are Alpha and Beta in Mutual funds calculated?

Alpha and beta in mutual funds are calculated through the Capital Asset Pricing Model (CAPM) formula. This formula facilitates the accurate calculation of a mutual fund’s risk-adjusted returns. The formula for calculating Beta in mutual funds is:

[(Mutual fund return- Risk-free rate)] / [(Benchmark return – risk free rate)] = Beta

The formula for calculating Alpha in mutual funds is:

[(Mutual fund return = Risk-free return)]- [(Benchmark return- risk free return) x Beta] = Alpha

Let’s take an example for clarity. For instance, a mutual fund offers 20% returns annually, with the benchmark return being 15%. Assuming the risk-free rate is 10%, Beta would be calculated as:

[(20-10)] / [(15-10)] = 2

This means that the mutual fund is twice as volatile as the benchmark return. Now, let’s calculate the Alpha, assuming Beta is 1.

[(20-10)] – [15-10)] x 1 = 5

This means that the fund outperforms the benchmark return and will be a good investment option.

To Sum Up

Now that you know what is alpha and beta in mutual funds, and what is alpha and beta formula, you’re better positioned to make an investment decision. All that’s left is choosing the right financial partner in your investment journey. For this, consider Tata Capital Moneyfy.

With Tata Capital Moneyfy, you get a platform that allows you to monitor your portfolio in a single click, invest in a proactive, responsible and safe manner, leverage comparison and scanner tools, and experience a completely hassle-free investment journey.

To learn more, visit the Tata Capital Moneyfy website or download the Tata Capital Moneyfy app today!