Focus on Funds | Nairametrics
In an attempt to help deepen the knowledge of mutual funds in Nigeria, I have decided to do a monthly series entitled “Focus on Funds.” In this series, I will randomly select a mutual fund and discuss the fund along the following lines:
In evaluating and selecting a mutual, one of the important areas to look at is the objective of the fund. This is because whether or not a fund is appropriate for you depends on whether the fund objective aligns with your investment objective.
Fund Investment Strategy
The investment strategy of a fund is a statement that outlines how the resources of the fund will be allocated across different security or investment types so as to be able to achieve the fund objective. Knowing the investment strategy of a fund will help you, the investor to determine if the fund is appropriate for you or not.
Fund Fee/Expense Ratio
Different funds have different fees and no matter how small the difference, it adds up at the end of the day. Knowing the expense ratio of a fund helps in making the choice of which fund to invest in.
It is often said in the arena of investing that past performance does not guarantee future performance. Though this is true, it helps to examine the past performances of funds that you are interested in investing in. By so doing, you can extrapolate into the future, not with exactitude but get an approximate view of what could be.
Knowing the holdings of the fund you are investing into or one that you intend to invest into helps you to know if the fund is or will be suitable for the achievement of your investment objective. Even though two funds may have the same or similar investment strategy, they may have different holdings or investments.
Beta measures how the prices of a particular mutual fund move up and down in comparison with a major index like the Nigerian All Share Index. A fund with a beta higher than that of the major index is expected to generate a return that is correspondingly better than that of the index.
R-Squared measures the percentage of a fund’s movement that is explainable or attributable to movements in its benchmark index. If a fund has an R-Squared of 100, it means that all the movements in the fund are due to movements from the benchmark index. So, knowing the R-Squared of a fund helps an investor to know how similar a fund is or could be to its benchmark. It also helps to know what funds to hold together so as to avoid overconcentration risk.
Alpha is a statistical measure that tells the investor how much value the fund manager adds or subtracts from a mutual fund. Alpha gives an investor an idea of what the expected return of a fund should be given its beta. For example, a fund with a Beta of 1.1 is expected to generate a 10% return above what its benchmark index generates, but if the fund ends up generating 15% return, then it means that the alpha is 5% and that the fund manager was able to add 5% return to the fund. Therefore, the higher the alpha the better the fund, so knowing the alpha of a fund helps investors select more rewarding funds.
Sharpe Ratio is often referred to as a risk-adjusted return measure. With the use of that ratio, an investor gets an idea about how a fund compensates for the amount of risk taken to invest in the fund or the risk inherent in the fund. It is often said that “high risk begets high return.” Sharpe Ratio helps to put that statement in perspective. Therefore, investors will be able to choose funds with a higher Sharpe Ratio because the higher the Sharpe Ratio, the better.
What this means to you
The whole gist and import of/from the above is, with the given information, the mutual fund investor will be in a better position to evaluate, compare and contrast between mutual funds. As earlier stated, I will randomly select the funds on which to focus each month, but readers are free to request a “focus analysis” on any fund of interest and I will subordinate my choice for that month to the readers’ choice.
So, look out for the first of the series!
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