Oftentimes, we hear that investors should not get carried away only with high returns given by mutual fund schemes. This is because a number or other factors such as stability and consistency of returns are also the virtues that need to be weighed among the pros and cons.
But how does one measure stability! Well, one such effective mechanism is through standard deviation.
First of all, let us define what exactly is a standard deviation in relation to a mutual fund.
Standard deviation is a useful tool to measure a fund scheme’s volatility which relates to the fluctuation in the net asset value (NAV) and consequently the fund’s performance.
In simple words, a higher standard deviation implies a higher volatility in returns relative to the average returns and therefore, it is inherently riskier.
On the other hand, a lower standard deviation implies fund returns are less volatile. Specifically, the funds with a long track record of consistent returns will show a low standard deviation.
However, investors should prioritise mutual funds which are akin to their risk tolerance. A higher or lower standard deviation does not mean that the fund is good or bad.
Now let us understand standard deviation with an simple example
“Average return hides the volatility in the fund’s return which standard deviation helps you to reveal. Say a mutual fund has given an average return of 12%. It’s just showing the average return and it doesn’t show the volatility during the period. Now say, the standard deviation of this fund is 15. The standard deviation of 15 indicates that the fund’s returns would go up or down by this value from its average,” says Nitesh Buddhadev, Founder of Nimit Consultancy.
Generally, debt mutual funds tend to have a low standard deviation compared to equity funds and sector funds, thematic funds, and small cap funds have a higher standard deviation.
Here is the list of mutual funds in relation to standard deviation
| Name of Schemes | 3-Year Returns | Standard Deviation |
| ICICI Prudential Bluechip Fund - Growth | 18.14 | 4.54 |
| SBI Magnum Midcap Fund - Growth | 30.74 | 4.78 |
| Axis Small Cap Fund - Reg - Growth | 30.93 | 4.31 |
| IDFC Nifty 50 Index Fund - Reg - Growth | 17.90 | 4.83 |
| ICICI Prudential FMCG - Growth | 16.89 | 3.52 |
| Parag Parikh Tax Saver Fund - Reg - Growth | 23.69 | 4.02 |
(Source: SMC report, as on 8 August)
Here, it is pertinent to note that standard deviation depicts the volatility in the returns so if one chooses a fund with a high standard deviation they should be ready to stomach the high volatility, Buddhadev added.
Abhishek Tiwari, Chief Business Officer, PGIM India Mutual Fund says, “Suppose fund Y and fund Z have both delivered 14% CAGR over a 3-year period. fund Y has SD of 23 while fund Z has SD of 15. An investor who would prefer a less bumpy ride would choose fund Z because of its low SD.”
Standard deviation should be only compared within the same peer group category of funds. The SD of a large-cap fund should only be compared with the SD of another large cap. The same goes for mid, small and other categories. You can’t compare the SD of a liquid fund with that of an equity fund because the SD of a liquid fund will always be low, he added.
Moreover, standard deviation also quantifies how much a fund’s return varies from its average and it can help investors measure the probable range of returns that one can achieve.
While evaluating a mutual fund performance holistically, standard deviation should be considered in conjunction with various other ratios such as alpha, sortino ratio, upside capture and downside capture.
Sanjay Chawla, CIO-Equity, Baroda BNP Paribas Mutual Fund says, “Investors should assess their risk appetite and then choose funds based on their ability to take risks in their investment portfolio. Investors with low risklow-risk tolerance should seek to invest in portfolios with a lower standard deviation vis-à-vis other funds.”
“Investors should also recognise that there is a trade offtrade-off between risk and returns. Funds with lower volatility may also have lower returns compared to funds with higher volatility. The investment decision should be an outcome of a comprehensive assessment of the risk appetite, investment horizon and expected returns,” Chawla added.
