The return alone cannot be considered as the basis of measurement of the performance of a mutual fund scheme, it should also include the risk taken by the fund manager because different funds may have different levels of risk attached to them. By using the risk return relationship, we try to access the competitive strength of the mutual funds vis-à-vis one another in a better way. A mutual fund may be ranked high both in terms of returns and risk-adjusted returns, but the important thing is that the investor should be aware of the level of risk. Also, performance in the scale of returns alone may not tally with the performance in terms of risk adjusted returns. Therefore, we can say that without taking into account the risk aspect it is not possible to find out the actual performance of any mutual fund. The risk return relationship proves that the funds taking higher (lower) amount of risk should give higher (lower) returns, if fund managers' skills are the same.

Generally the primary objective of the investors of equity funds is to maximize returns at a particular level of risk. His expected returns from the funds that are taking different level of risk are different. So, the fund manager's efficiency should be governed by the return given by the funds over and above the expected return of the funds at the level of risk associated with it. The Eugene Fama model is the best model for ranking equity funds as it compares the performance (measured in terms of returns) of the fund with the required return commensurate with level of risk associated with the fund. The difference between actual return of fund and required return for particular level of risk is taken as a measure of the performance of the fund and is called net selectivity.

The net selectivity, as defined in this model, measures the excess return earned by the fund manager entirely due to their stock selection skill, as it is the excess return over and above the return required to compensate for the total risk taken by the fund manager. Higher value of which indicates that fund manager has earned returns well above the return commensurate with the level of risk taken by him.

However, it is lower level of risk, as compared to equity funds, that attracts the investors in debt funds. So, for the investors of the debt funds, return per unit of risk should be the criterion of evaluation of funds. The Debt funds are ranked on the basis of excess return per unit of risk where risk is measured by the standard deviation of the rate of return. The ratio is widely known as Sharpe’s Reward to variability ratio.

Different parameters have been calculated as follows :

First step in measuring performance of a fund is to calculate its returns during the period for which performance is being measured. Return is calculated as percentage change in NAV after adjusting for dividend or bonus. Periodic returns have been calculated so as to give weightage to the periodic fluctuations in the NAVs of the funds.

After calculating periodic returns of a fund, the average rate of return of the fund has been calculated for the period for which the performance is to be calculated. The average return of the fund has been calculated by dividing summation of all returns by number of periods.

Same methodology has been used for calculating return from market index as well.

Risk free rate of the economy has been taken as 8.5 per cent, which is the rate of return generated on practically risk-free instruments of two to three years maturity like bank deposits, Government of India guaranteed bonds, etc.

This required rate of return, as calculated above, is then compared with the actual return earned by the fund during the period to judge its performance. Differential between the required return and actual return is the parameter for ranking the fund.

This differential (Net Selectivity) measures the stock selection skills of the fund managers. Higher the values of net Selectivity better the fund managers' stock selection skills. Whereas, the negative value of it shows that the fund manager was not able to get the returns according to the level of risk taken by him.

Consider Zurich India Top 200 Fund. The average weekly return on the fund was 0.1974 per cent as on March 30, 2001, for the period of last three years. The average weekly risk-free rate of return during the period calculated as explained earlier was 0.1635 per cent. The average daily return on Sensex (market index) was 0.1349 per cent during the same period. The measure of fluctuations of the returns, standard deviations, for market index and Zurich India Top 200 Fund during the period were 4.61 and 4.18 respectively.

The risk (b ’) of the Zurich India Top 200 Fund during this period can be worked out by dividing standard deviation of the returns on the UTI Growth Service Sector Fund during this period by the standard deviation of the returns on the Market Index. It was calculated to be 0.9067.

Thus, the required return of Zurich India Top 200 Fund to compensate for this risk works out to –.1436. This required rate of return commensurate with the level of risk of Zurich India Top 200 Fund is deducted from the average weekly rate of return of the fund (0.1974 per cent) to get the Net Selectivity, which works out to be 0.341. This is highest among all equity funds making it top performing equity fund.

Risk ratings have been done on the following factors :

Based on the factor, the schemes have been classified into three categories-

* Low Risk: bottom one third of the risk scale

Performance ranking has been done on the basis of differential of actual return generated and required return for total risk taken by the fund within the universe of Equity, Balanced and Debt Funds (Universal Rank) as well as within the category to benchmark the performance with other similar types of funds (Category Rank).

Categorisation of the funds has been done as follows.

* Equity Funds

* Equity Tax Saving Schemes

* Diversified Equity Funds (latest portfolio containing less than 40 per cent in ICE or in any single sector)

* Debt Funds

* Balanced Funds (max 66.67 per cent equity){ balanced funds have been categorised on the basis of its latest investment pattern and not just the name or stated nature}

* Short-term debt: this will include Liquid funds and Money Market funds.

* G'Sec funds.

These have been further categorised depending on whether they are open end or close end.