Here’s how Beta helps evaluate short-term investments

In India, investors have various ways of comparing two mutual funds of the same category. They generally compare previous returns, expense ratios, and Net Asset Values (NAVs) of mutual funds. Seasoned investors also compare two mutual funds using their Beta values to analyse them better. Every mutual fund is related to a benchmark index, and understanding the Beta of a mutual fund can provide crucial insights into its performance. This article will explain the concept of Beta in mutual funds and guide you on evaluating overnight funds using their Beta values.

What is the Beta of a mutual fund?

The performance of a mutual fund is measured against a standard called a benchmark index. For instance, if you invest in a medium-cap mutual fund, its benchmark index could be the Nifty Midcap 100. The benchmark index typically has a Beta value of 1. Beta measures a mutual fund’s sensitivity to market movements relative to its benchmark index. If the benchmark index returns 8%, you would expect your mutual fund to also return 8% if its Beta is 1. However, if the Beta of the mutual fund is 1.5, you will anticipate a return of 12% if the index returns 8%.

What are overnight mutual funds, and what are their features?

Overnight funds are open-ended debt mutual fund schemes that invest primarily in overnight securities. These funds are known for their unique features, making them particularly suitable for short-term investments:

  • Overnight funds have a low-risk profile and offer higher profits:

Overnight funds are low-risk investments that provide relatively higher returns than traditional savings accounts or fixed deposits. They primarily invest in extremely short-term securities, reducing the risk associated with interest rate fluctuations.

  • Overnight funds offer high liquidity:

Investors can redeem their overnight fund investments any time without any exit load. This feature makes them an excellent choice for those who want quick access to their funds.

  • Overnight funds act as emergency funds:

Overnight funds can double up as emergency funds due to their low-risk nature and high liquidity. You can park your surplus cash in these funds and still earn a reasonable return while keeping your funds readily available for unexpected expenses.

  • They have a short investment horizon:

Overnight funds are designed for short-term investment horizons. They are suitable for investors with a timeframe of a few days to a few weeks, making them an ideal choice for individuals who need to park their funds temporarily.

How to evaluate short-term funds by checking their Beta values?

You can use the following formula to calculate the Beta of a mutual fund:

Beta = (Fund return – Risk-free rate) / (Benchmark return – Risk-free rate)

Investors can within the same category by comparing their Beta values. Here’s how it works:

  • Funds with a high Beta value offer high returns: If you find an overnight fund with a Beta greater than 1, it suggests that the fund’s returns are expected to be more volatile than its benchmark index. In a rising market, this can translate to higher returns..
  • Funds with a lower Beta value offer downside protection: Conversely, a fund with a Beta less than 1 is expected to provide downside protection during market downturns. This is beneficial for risk-averse investors who want stability in their short-term investments.

Understanding a mutual fund’s Beta relative to its benchmark index can provide insights into its risk-return profile. Investors can make informed decisions tailored to their investment objectives and risk tolerance by considering the Beta values of different mutual funds.

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