How to Use Statistical Analysis With Mutual Funds

Learn How to Pros Analyze Mutual Funds

analyzing mutual funds stock
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Fortunately, you don't have to be a math wizard to analyze mutual funds like the pros. All of the key statistics and quantitative measures have already been calculated. So to find and buy the best mutual funds, the primary knowledge or skill you need is to understand how to use these measures and where to find them.

Statistical analysis of mutual funds is just what it sounds like--a means of studying the quantitative aspects of a fund to help the investor gain an understanding of past performance for a clue about future results.

Yes, there is no "guarantee" of future results but investing is not about guarantees--it's about taking calculated risk.

Analyzing Mutual Funds With Statistical Measures

Statistical analysis of mutual funds requires a fundamental knowledge of quantitative measures, such as Beta, R-squared, Alpha, Sharpe Ratio, Expense Ratio, and Tax Cost Ratio:

  • Beta: Beta, with regard to mutual fund investing, is a measure of a particular fund's movement (ups and downs) compared to the overall market. For reference, the market is given a beta of 1.00. If a fund's beta is 1.10, this fund would be expected to have a return of 11% (1.10 is 10% higher than 1.00) in an up market but the same fund would be expected to decline 11% when the market declines 10%.
  • R-squared: According to Morningstar, "R-squared reflects the percentage of a fund’s movements that can be explained by movements in its benchmark index. An R-squared of 100 indicates that all movements of a fund can be explained by movements in the index." In translation, R-squared helps an investor check how similar a particular fund may be to a given index. For example, if you already have an S&P 500 fund in your portfolio, you won't want to add another mutual fund with an R-squared of 0.99 because this indicates a correlation of 99% to the S&P 500. The new prospective fund would perform almost identical to the S&P 500 fund already in your portfolio. That's not diversification!
  • Alpha: This is a measure that can give you an idea how much value the fund manager adds to (or subtracts from) the mutual fund. Alpha gives an expectation of returns above (or below) what the beta would predict. Following our example in beta (above), if the beta is 1.10 and the market moves higher by 10%, a fund with a positive alpha would be expected to have a return higher than 11% (the amount predicted by beta). You want to find funds with a positive alpha!
  • Sharpe Ratio: Using the Sharpe Ratio, an investor can gain an expectation as to how well the return of a particular mutual fund compensates the investor for the risk taken. Put simply, the higher the Sharpe Ratio, the better. For example, receiving high relative returns for taking an average or below-average level of risk is favorable and Sharpe Ratio can help provide calculated forecasts for this potential outcome.
  • Expense Ratio: Often, it is the funds with the lowest expenses that do the best, especially over long periods of time (i.e. 10 years or more) because expenses tend to be a drag on performance.
  • Tax Cost Ratio: If you are investing in a taxable account, you want to be careful of investing with funds that generate income (i.e. dividends, capital gains distributions) that can be taxed. More taxes equals lower net returns back to you, the investor.

Note: With exception of Expense Ratio and Tax Cost Ratio, the quantitative measures listed in this article are best used for researching actively-managed funds, not Index funds.