Ritesh Sabharwal CFP®

W.M.W #31: (Part 5/5): The 7 Ratios that separate great mutual funds from average ones

Reading time: 5 minutes - January 17, 2026

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Hey Reader

In continuation of the Mutual fund series, last week I explained equity, debt, and hybrid funds to my cousin based on goal timelines and risk appetite.

Her immediate follow-up question:

Cousin: With so many funds available, how should I evaluate which one is actually good?
​Me: Most people pick funds based on past 1-year or 3-year returns. That's a mistake.
​Cousin: Why? Isn't higher return better?
​Me: Not always. A fund giving 15% returns with 30% volatility is worse than a fund giving 13% returns with 10% volatility. You need to look at risk-adjusted performance, not just returns.
​Cousin: Risk-adjusted? How do I measure that?
​Me: Through 7 performance ratios. Once you understand these, you'll never pick a fund blindly again.

Here's what I explained - the framework professional investors use to evaluate mutual funds.

Why Returns Alone Don't Tell the Full Story

Let me show you a real example:

Most investors would pick Fund B. Higher return = better fund, right?
​Wrong.

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​Now let's add one more data point:

Suddenly, Fund A doesn't look so bad. Fund B's extra 4% return came with 3.5x more volatility. During market crashes, Fund B fell 40% while Fund A fell only 12%.

This is why we need performance ratios - they reveal the hidden story behind returns.

The 7 Performance Ratios Every Investor Must Know

1. Beta (β): How Volatile is the Fund vs Market?

What it measures: Fund's volatility compared to its benchmark index
​Formula: Statistical calculation comparing fund's price movements with benchmark

What you want:

• For aggressive investors: β > 1 (willing to take higher risk for higher returns)
• For conservative investors: β < 1 (want stability over extra returns)

Beta helps investors understand whether a fund will swing more or less than the broader market during ups and downs

2. Alpha (α): Is the Fund Manager Adding Value?

What it measures: Fund manager's skill in generating excess returns above benchmark after adjusting for risk. Alpha is the excess returns relative to market benchmark for a given amount of risk taken by the scheme

Formula:
​α = Fund Return - [Risk-free rate + β × (Benchmark return - Risk-free rate)]

What you want:

• Positive alpha consistently over 3-5 years
• Shows fund manager has genuine skill, not just luck

Alpha in mutual funds is probably the most important performance measure of a mutual fund scheme

3. Sharpe Ratio: Best Risk-Adjusted Returns

What it measures: How much return you're getting for each unit of total risk taken
​Formula:
​Sharpe Ratio = (Fund Return - Risk-free Rate) / Standard Deviation

For a mutual fund with a return of 12%, a risk-free rate of 5%, and an SD of 10%, the Sharpe Ratio comes to 0.7, meaning the fund generated 0.7 units of return for each unit of risk taken

What you want:

• Higher Sharpe ratio = better risk-adjusted returns
• Compare Sharpe ratios within the same fund category (don't compare large-cap Sharpe with small-cap)

A higher Sharpe ratio indicates better risk-adjusted returns, implying the fund generated higher returns relative to the level of risk undertaken

4. Sortino Ratio: Downside Protection

What it measures: Risk-adjusted returns, but considers ONLY harmful downside volatility (ignores upside swings). The Sortino ratio is similar to the Sharpe ratio but focuses only on downside risk, considering the standard deviation of negative returns

Formula:
​Sortino Ratio = (Fund Return - Risk-free Rate) / Downside Deviation

Why this matters:

Not all volatility is bad. If a fund swings from +15% to +25%, that's good volatility. Sortino ratio focuses exclusively on the volatility that hurts—downside deviation

How to interpret:

• Sortino > 2: Excellent downside protection
• Sortino 1-2: Good
• Sortino < 1: Poor downside protection

A high Sortino ratio indicates that the fund is less exposed to downside deviation and has given better risk-adjusted returns

5. Information Ratio: Consistent Outperformance

What it measures: How consistently a fund beats its benchmark relative to tracking error
​Formula:
​Information Ratio = (Fund Return - Benchmark Return) / Tracking Error

Tracking error means standard deviation of the difference between portfolio and benchmark returns

What you want:

• IR > 0.75 shows genuine manager skill
• Higher IR = more consistent outperformance

6. Capture Ratio: Bull Market vs Bear Market Performance

What it measures: How well a fund captures upside (bull markets) vs downside (bear markets)
​Formulas:
​Upside Capture = (Fund returns during bull market / Benchmark returns) × 100
Downside Capture = (Fund returns during bear market / Benchmark returns) × 100

How to interpret:

• Upside Capture > 100: Fund captures MORE gains than benchmark in bull markets
• Downside Capture < 100: Fund loses LESS than benchmark in bear markets (good!)

What you want:

• Capture Ratio = Upside / Downside
• Capture Ratio > 1.5 is excellent (captures more upside, protects more on downside)
• Example: Upside 115 / Downside 80 = 1.44 (very good)

A capture ratio above 1 means the fund delivers better risk-adjusted returns

7. Treynor Ratio: Returns per Unit of Market Risk

What it measures: Excess returns per unit of systematic (market) risk, using Beta instead of total volatility. Treynor ratio, like the Sharpe ratio, shows the extra returns above the risk-free rate of return. The only difference is that it considers Beta and not Standard Deviation

Formula:
​Treynor Ratio = (Fund Return - Risk-free Rate) / Beta

How to interpret:

• Higher Treynor = better returns for systematic risk taken
• Useful for well-diversified portfolios where only market risk matters

What you want:

• Compare Treynor ratios across funds with similar diversification
• Higher is better

A higher Treynor ratio means the fund has given better returns considering its systematic risk

What My Cousin Understood After This

After explaining these 7 ratios, she said:

Cousin: So basically:

• Alpha = Manager's skill in beating benchmark
• Beta = How volatile compared to market
• Sharpe Ratio = Returns per unit of total risk
• Sortino Ratio = Returns per unit of downside risk
• Information Ratio = Consistency of outperformance
• Capture Ratio = Performance in bull vs bear markets
• Treynor Ratio = Returns per unit of market risk

Me: Exactly. And you don't need to calculate these yourself - sites like Value Research, Morningstar, and Groww show all these ratios.
​Cousin: This changes everything. I was about to invest in a fund just because it had 15% returns last year. Now I'll check these ratios first.

The Bottom Line: Beyond Returns

Choosing mutual funds based solely on past returns is like judging a car by its speed without checking safety features, fuel efficiency, or engine health. Investors who systematically apply ratio analysis typically improve risk-adjusted returns by 1.5-3% annually - which compounds to 30-60% more wealth over 20-30 year investment horizon.

Most people pick funds by sorting highest to lowest returns. That's gambling, not investing.

Smart investors ask:

1. Is the fund manager skilled? (Alpha)
2. Is the fund too volatile? (Beta, Sharpe, Sortino)
3. Does it perform consistently? (Information Ratio)
4. Does it protect during crashes? (Sortino, Downside Capture)

When you filter funds using these ratios, you eliminate 80% of mediocre funds and focus only on genuinely great ones.

Final Thoughts: The 5-Part Series Wrap-Up

Over the past 5 weeks, we covered:

Part 1: What is a Mutual Fund? (Pooling, NAV, Units)
​Part 2: MF Concepts (AMC, AUM, NAV, NFO, Expense Ratio, PTR)
​Part 3: Types of MF (Open vs Closed, Active vs Passive, Direct vs Regular, Equity vs Debt vs Hybrid)
​Part 4: Asset-Based Types (Equity, Debt, Hybrid funds and categories)
​Part 5: Performance Ratios (Alpha, Beta, Sharpe, Sortino, Capture, Information, Treynor)

You now know more about mutual funds than 95% of investors in India.

The difference between you and them? They pick funds based on emotions and recent returns. You will pick based on data and ratios. That edge compounds into lakhs of extra wealth over 20-30 years.

This concludes the 5-part Mutual Fund series. Thank you for reading till the end!

Got questions about any ratio or need help evaluating your current funds? Hit reply - I read every email and will help you analyze your portfolio.

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