Alpha vs Beta Ratios in Mutual Funds: Key Differences Explained

Alpha vs Beta Ratios in Mutual Funds: Key Differences Explained

Choosing the right mutual fund is crucial, so it's important to understand two key terms: Alpha and Beta. These ratios help you to know a fund well, how it has performed, and how risky it is compared to the market. Here we will explore more about the difference between Alpha vs Beta ratios in mutual funds.

What is Alpha Ratio?

Alpha tells you how much extra return a mutual fund has given compared to its benchmark, like the Nifty 50. It is a measure of investment performance relative to a benchmark index, such as the S&P 500.

It represents the extra return, so it is also called the active return, of an investment or portfolio generated above or below the benchmark. It is one of the most common technical analysis ratios in the stock market.

For example, suppose the Nifty 50 benchmark gave a 10% return in 5 years, and your mutual fund gave 13% in the same period. So the Alpha is +3% (13% - 10%). This means the fund manager gave you 3% more than the market average.

How to use Alpha

Look for funds with positive Alpha, especially if it’s consistent over time. Remember, Alpha is based on past data. It does not guarantee future performance. If a fund has a negative Alpha, it’s better to avoid it. Let’s understand in detail:

  • Zero Alpha: The investment has matched the benchmark performance, adjusted for risk.
  • Positive Alpha: The investment has outperformed the benchmark. For example, if a fund returned 10% and the benchmark returned 8%, the Alpha is +2%.
  • Negative Alpha: The investment has underperformed compared to the benchmark. For example, if a fund returned 6% while the benchmark returned 8%, the Alpha is -2%.

What is Beta Ratio?

Beta tells you how much a fund’s returns move compared to the market. It shows how volatile (risky) the fund is. It is a statistical measure that reflects how much a stock price moves relative to overall market movements.

It is typically compared to a benchmark index like the S&P 500, which is assigned a Beta of 1.0. Beta measures the volatility of a security relative to the market, showing how a stock’s price changes when the market changes. Types of Beta ratio:

β>1 The stock is more volatile than the market.
β=1 The stock’s volatility is equal to the market's.
β<1>0  The stock is less volatile than the market.
β=0 The stock is uncorrelated with the market, implying no market risk.

For example, if a fund’s Beta is 1.2 and the market goes up by 10%, the fund may go up by 12%. If the market falls by 10%, the fund may fall by 12%. Similarly, if a fund’s Beta is 0.8 and the market falls by 10%, the fund may only fall by 8%.

How to use Beta

  • High Beta: In this case, investors have a higher chance of returns, but also higher risk.
  • Low Beta: In low Beta, there are more stable returns and lower risk.
  • Large Cap Funds: These usually have a low Beta and are also less risky.
  • Mid Cap & Small Cap Funds: In this case, Beta is usually high and also riskier.

How to Select Mutual Funds Using Alpha and Beta?

Here you can select mutual funds by using Alpha and Beta:

  • Check if Alpha is consistently positive.
  • See if Beta matches your risk level.
  • If you are a low-risk investor, choose funds with Beta < 1.
  • If you are a high-risk, high-return investor, you can consider Beta > 1 (but be careful).
  • The best scenario is when Alpha is high and Beta is low, which means the fund manager has given good returns with less risk.
  • If Alpha is low and Beta is high, then the fund is risky and does not give extra returns, so avoid such funds.

You can watch our detailed video on Alpha vs Beta Ratios in Mutual Funds for full insights.

Difference between Alpha and Beta ratio

Here are the differences between the Alpha vs Beta ratios:

Feature  Alpha    Beta
What it measures Excess return over benchmark, risk-adjusted. Volatility compared to the benchmark
Ideal Value Higher, a positive Alpha is better Beta close to 1 for market-like risk; <1 for lower risk
Indicates Fund manager’s skill and value addition Fund’s sensitivity to market movements
Use Case To judge outperformance and fund manager effectiveness To assess risk and volatility

Also, check - What’s the Difference Between Index Funds and Active Funds?

Conclusion 

In conclusion, it is not a battle, it is a balance. A smart investor looks at both metrics to evaluate a mutual fund's potential for risk and growth. So, you can also check Alpha and Beta ratios on mutual fund investment apps like Groww, Zerodha, etc., and the official website of the mutual fund. We hope this blog has been helpful to you.

About the Author

Saniya

I am a writer, and this sentence speaks louder than anything, I love to play with words because I have a passion for writing easy and good-quality content that reflects simplicity. Readers like content that is straightforward with simple language. My priority has always been to deliver content that connects with the reader.

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