What Does Standard Deviation Measure In a Portfolio?

A mutual fund with a long track record of consistent returns will display a low standard deviation. A growth-oriented or emerging market fund is likely to have greater volatility and will have a higher standard deviation. This measurement of average variance has a prominent place in many fields related to statistics, economics, accounting, and finance.

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In actuality, 3, what is standard deviation in mutual fund 5, and 10-year trailing monthly returns are used to assess the standard deviation. All monthly standard deviation measurements are additionally annualised and displayed as a percentage. In practice, the standard deviation is estimated using 3, 5 and 10 year trailing monthly returns.

Importance of Standard Deviation in Mutual Funds

In contrast, a fund that has a wide negative return from the mean will also have a high SD. Thus, it needs to be looked at in conjunction with other ratios/metrics like Sortino Ratio, Sharpe Ratio, Upside Capture Ratio, Downside Capture Ratio, Alpha, Beta and R2. While important, standard deviations should not be taken as an end-all measurement of the worth of an individual investment or a portfolio. Due to its consistent mathematical properties, 68% of the values in any data set lie within one standard deviation of the mean, and 95% lie within two standard deviations of the mean.

Drawbacks of Standard Deviation Measurement

The standard deviation of funds in the equity category will be higher than those in the debt category. A standard deviation is a statistical tool that helps measure the deviation in portfolio returns from its average. The standard deviation has wide use in determining the risk of an investment. It is an important metric to consider while investing in market-linked instruments. Since markets are volatile, the returns fluctuate on a daily basis. These fluctuations depend on various internal and external factors.

It can be used to analyse the historical performance of a fund in isolation. Suppose Fund A and Fund B have both delivered 13% CAGR over a 3-year period. An investor who would prefer a less bumpy ride would choose Fund B.

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When applied to historical returns over a period the standard deviation can be used as a tool to measure the volatility of a fund. However it is essential to understand that standard deviation works based on the law of averages and just like all other spheres of life averages can neither be good nor bad on their own. For example a mutual fund scheme with a standard deviation of 3 can only be considered better or worse than another with a standard deviation of 4 or 2. The standard deviation can be used to assess a fund’s volatility when applied to historical returns over time. It is crucial to realise that standard deviation is founded on the law of averages and that averages cannot be good or bad on their own, just like in all other areas of life.

Similarly, HDFC Top 100 is more sensitive to market movements with a higher beta and a negative alpha implies that the fund may not have been able to keep up with the category returns. By the definition of standard deviation, it is a measure of volatility Sharpe Ratio measures risk-adjusted performance or how well a fund performs compared to its volatility. Alpha indicates how much value has been either added or subtracted by the fund manager’s investment call and Beta on the other hand marks how sensitive a fund can be to market movement.

Beta is a relative risk and does not reveal the fund’s inherent risk. You must compare a fund’s standard deviation to other schemes in the same category to determine whether it is high or low. Debt mutual funds are one example of a low-risk strategy with a low standard deviation.

This implies,  if S&P Sensex 500 falls by  1%, then Tata Multicap fund is expected to fall by 0.95%. But keep in mind that standard deviation is most useful when analyzing the past performance of one mutual fund in isolation. Investors holding several mutual funds cannot take the average standard deviation of their portfolio in order to calculate their portfolio’s expected volatility. We can see that the Sharpe ratio of the HDFC top 100 plan is higher and the fund provides lesser returns per unit of this volatility at 0.32. Whereas Kotak Bluechip is not only less volatile but also generates more returns per unit of volatility at 0.47.

When a fund manager makes an investment decision, Alpha shows how much value has been created or removed, and Beta shows how sensitive. Also you can search about standard deviation formula to know the actual details. You cannot decide if the standard deviation of a fund is high or low unless you compare it to other schemes in the same category. Low-risk schemes such as debt mutual funds tend to have a low standard deviation.

1. When investing in mutual funds, we frequently use returns as a criterion for evaluation.
2. Beta is a measure of volatility; it tells us how risky the fund is when compared to its benchmark.
3. Since markets are volatile, the returns fluctuate on a daily basis.
4. While important, standard deviations should not be taken as an end-all measurement of the worth of an individual investment or a portfolio.

As an illustration, a mutual fund strategy with a 3-standard deviation. Standard Deviation indicates the volatility of the fund’s returns. Higher standard deviation means higher variation in returns and vice versa.

Registered readers can post their queries by accessing the Ask Morningstar tab. Our team will answer SELECT queries ONLY relating to mutual funds and portfolio planning. SD is a measure of volatility and denotes the variation in the observed values of a data series about its mean (average). Measuring standard deviation will help the investors see how consistent the rate of return has been over a time period. For example, a growth-oriented fund or an emerging market fund will have greater volatility than a debt fund.

Standard deviation is a statistical measurement that shows how much variation there is from the arithmetic mean (simple average). Investors describe standard deviation as the volatility of past mutual fund returns. Volatility is not the same as risk, but it is an anticipation or reaction to a risk event. A highly volatile fund poses greater risk to the investor than a fund with lower volatility. Volatility in the market provides the investors an impression that they are losing out on money, but that is not necessarily true.

Because many investment techniques are dependent on changing trends, being able to identify highly volatile stocks at a glance can be especially useful. But in reality, you cannot isolate risk and reward; you need to factor in both these and figure out which of these two are better. The inherent risk of a fund is revealed by the ‘Standard Deviation’ of the fund. There are two return sources which fit in the above definition  – (1) The return from the savings bank account (2) The fixed deposit return. Well, the good, bad, ugly part of beta depends on another metric called the ‘Alpha’.

Developed by the technical trader John Bollinger in the 1980s, Bollinger bands are a series of lines that can help identify trends in a given security. Generally speaking, the SD for mid and small-cap funds are higher compared to large-cap stocks. The SD of the small-cap fund is 23.95% while the long term equity is 19.33%, which implies that the small-cap fund is way riskier compared to the long term equity fund. I’d suggest you go through that entire chapter to understand the concept of standard deviation and volatility.