THE METHODOLOGY

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.

Performance of a fund in isolation does not infer any thing. Therefore, there should be a benchmark against which the return should be judged. Secondly 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. The 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.

Hence, it is clear from our discussions that a good risk adjusted performance measure should consider the entire risk associated with the fund, and should be able to compare the performance of the portfolio with certain well-defined benchmark. The Eugene Fama model has all the above characteristics, 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.

Different parameters have been calculated as follows :

Calculation of Returns

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 Return

Risk free rate of the economy has been taken as 9.5 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.

('--A Measure of Total Risk of a Fund

(' is a measure of total risk--systematic risk plus unsystematic risk--of a mutual fund scheme and is calculated by multiplying standard deviation of the returns of scheme and standard deviation of the returns of market index.

After calculating all the above parameters, the required rate of return (R') commensurate with the given level of risk of the mutual fund (' as measured above, is calculated as Required Rate of Return=Risk Free Rate + Total Risk (Market Return-Risk Free Rate).

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.

Illustration

Consider the Alliance capital Tax Relief '96 Fund. The average weekly return on the fund was 2.1535 per cent as on June 30, 2000, for the last three years. The average weekly risk-free rate of return during the period calculated as explained earlier was 0.1826 per cent. The average daily return on NSE-Nifty (market index) was 0.7937 per cent during the same period. The measure of fluctuations of the returns and standard deviations for market index and Alliance capital Tax Relief '96 Fund during the period were 6.1283 and 4.9145 respectively.

The risk ((')of the Alliance capital Tax Relief '96 Fund during this period can be worked out by dividing standard deviation of the returns on the Alliance capital Tax Relief '96 Fund during this period by the standard deviation of the returns on the Market Index. It was calculated to be 1.246983.

Thus, the required return of Alliance capital Tax Relief '96 Fund to compensate for this risk works out to 1.2088. This required rate of return commensurate with the level of risk of Alliance capital Tax Relief '96 Fund is deducted from the average weekly rate of return of the fund (2.1535per cent) to get the Net Selectivity, which works out to be 1.2088. This is highest among all equity funds making it top performing equity fund.

Mutual Funds Risk Rating

Risk ratings have been done on the following factors :

Equity Fund: Beta of the weekly NAV of the schemes vis-a-vis Nifty.

Debt Fund: Beta of the weekly NAV of the schemes vis-a-vis I-bex, as declared by I-Sec.

Balanced Fund: Beta of the weekly NAV vis-a-vis a new index calculated by giving 60 per cent weight to Nifty and 40 per cent to I-bex.

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

* High Risk: top one third of the risk scale

* Average Risk: middle one third of the risk scale

* Low Risk: bottom one third of the risk scale

Performance Ranking

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

* Skewed Equity Funds (latest portfolio containing more than 60 per cent in ICE)

* Aggressive Equity Funds (latest portfolio containing 40 to 60 percent in ICE)

* 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.

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