Here is a selected glossary of the iFundScores algorithm's display metrics:
Definition: Alpha is the excess return of a fund relative to the return of the benchmark. Alpha is represented by a single number (2 or -3), and refers to a percentage of how the fund performed compared to the benchmark (i.e. 2% better or 3% worse).
How to use: Funds usually charge a fee, so when a fund nets an alpha of 0, it actually represents a net loss for the investor. For example, a fund charges 1% of a portfolio’s value for services, and during that 12-month period, the fund generates an alpha of .85. The fee that the fund charges is in excess of the alpha generated, and thus, the portfolio experiences a net loss. In short, it is good to compare the fund’s fee to the alpha to ensure the portfolio doesn’t see a net loss.
Definition: Annualized return is the average amount of money earned by an investment over a given 12-month (year) period. Annualized return only provides a small amount of data for an investment’s performance, and does not give any indication of the it’s volatility.
How to use: An investment could fluctuate between losing 5% and earning 10%, and have an annualized return of 5%. Another investment could earn between 2 to 4% throughout the year, and have an annualized return somewhere between those two values (i.e. 2.875%). When looking at annualized return, it is wise to look at the volatility (beta) to make sure it matches the investor’s investment policy.
Definition: Batting average is the track record of an investment manager’s ability to match or beat the index. It is calculated by dividing the total number of days the investment manager matches or beats the index by the total number of days in the period (month, quarter, year, etc.) multiplied by 100.
How to use: A higher batting average shows that an investment manager has met or exceeded the index as compared to others. An investor should look at the batting average over long time periods to determine whether the investment manager has a good track record. IFS publishes batting average for 3 and 5 years, so the investor can rest assured about a good data sample.
Definition: Beta is a measure of volatility, or risk, of a fund compared to the market as a whole. If a fund’s beta is greater than 1, it communicates that the fund will be more volatile than the market. If a fund’s beta is less than 1, it communicates that the fund will be less volatile than the market. If a fund’s beta is 1, then the fund will move with the market. Beta is represented by a single number (1.5 or 0.8), and anything above or below 1 refers to a percentage (i.e. 50% more volatile or 20% less volatile). As the market goes up, a fund with a beta of 1.5 will go up 50% more than the market.
How to use: Beta is based off of historical data points, so it cannot predict the future. and higher the possible return or loss. A fund’s beta should match the investor’s investment policy.
Definition: Calmar Ratio compares the average annual rate of return and the maximum drawdown of an investment. Basically, it measures an investment’s percentage return per percentage of risk over a period of time.
How to use: A higher Calmar Ratio means there is a higher rate of return per unit of risk. A higher Calmar Ratio notes a better performing investment. A lower Calmar Ratio denotes a low performing investment.
Definition: Capture Spread is an iFS proprietary metric that measures the difference between the upside and downside capture ratios.
How to use: The capture spread shows if the portfolio manager is actively trying to out-perform in an up-market and down-market. The larger the spread, the better the portfolio manager is in managing both markets.
Downside Capture Ratio
Definition: Downside Capture Ratio measures an investment manager’s ability to out-perform the index in down-markets.
How to use: Downside Capture Ratio is calculated by dividing the investment manager’s return by the return of the index in the down-market, and multiplying it by 100 to get a percentage. A value less than 100 means the investment manager out-performed the index. A value greater than 100 means the investment manager under-performed the index. A value of 60 specifies that the investment declined 60% as much as the index during the down-market. Thus, a lower number is better during a down-market.
Definition: Excess return is the return an investment delivers above the index. Also known as Alpha.
How to use: Check to see that the excess return, or alpha, is larger than the fee the fund charges. Otherwise, the portfolio experiences a net loss.
Definition: Expense ratio is an annual calculation of how much it costs the investment company to operate divided by the average dollar value of total assets under the company’s management.
How to use: The expense ratio is a handy way for investors to understand how "expensive" a fund is, on a relative basis. The costs of managing a $50 billion fund , in absolute terms, will be much higher than for a $50 million fund. But when the total expenses are compared against the assets under management, it allows for an apples-to-apples comparison.
Definition: Gain to loss ratio is a metric not dependent on the benchmark, and gives insight to how well the fund does in an up period and down period by comparing the absolute average returns in both periods.
How to use: Gain to loss ratio is calculated by dividing the absolute average gain in an up period by the absolute average loss in a down period. A value less than 1 means the investment’s average return is worse in down periods. A value greater than 1 means the investment’s average return is better in up periods. A value of 1 indicates the investment’s average return is equally balanced in up and down periods.
Definition: Information ratio is the ratio of the investment’s return above the return of the index divided by the volatility of those returns. It measures the investment manager’s ability to beat the index, but also the consistency of the investment manager.
How to use: A higher information ratio indicates a more consistent investment manager.
Definition: Maximum drawdown is the worst high to low loss since the investment's inception.
How to use: Maximum drawdown is used in calculating Calmar Ratio.
Rate of Return
Definition: Loss or gain on an investment over a period of time. Rate of return is usually expressed as a percentage increase or decrease over the initial investment.
How to use: Rate of return is perhaps the most important measure of a fund's value over time.
Definition: Theoretical rate of return of an investment with no risk of financial loss. Risk-free rate is the minimum return an investor should expect from an absolute risk-free investment.
How to use: The risk-free rate does not exist because even the safest investments carry risk. For US Investors, the risk-free rate is often considered the interest rate on a three-month US Treasury Bill.
Definition: R-squared is a measure of correlation between an investment and an index. It measures how closely the investment moves with the index.
How to use: At iFundScores, we use R-squared values greater than .70 (70%) to correlate an investment with the appropriate category and index.
Definition: Sharpe ratio calculates risk-adjusted return. Sharpe ratio is calculated by subtracting the risk-free rate from the average return of the investment, and then dividing this value with the investment’s standard deviation.
How to use: A higher Sharpe ratio usually means a more attractive investment. However, by using standard deviation alongside this value, one can determine if the whether the investment’s excess return was due to a smart investment decision, or due to risk.
Definition: Sortino ratio is a modification of the Sharpe ratio. Sortino ratio takes into account harmful volatility when Sharpe ratio does not. Sortino ratio is calculated by subtracting the risk-free rate from the average return of the investment, and then dividing this value with the investment’s downside deviation.
How to use: Sharpe ratio is good for evaluating low volatile investments, while Sortino ratio is good for evaluating high volatility investments. What do high values and low values mean? Positive or negative values?
Definition: Standard deviation is used to measure the variance of an investment from its annual return. Standard deviation measures historical volatility.
How to use: Standard deviation helps the investor understand the risk in an investment. Higher standard deviation denotes an investment that has higher volatility. Conversely, an investment with a lower standard deviation has a lower volatility. Check to make sure the investment’s standard deviation (volatility) lines up with your investment policy.
Definition: Treynor ratio is also known as the reward-to-volatility ratio. Treynor ratio is similar to Sharpe ratio, but is calculated by using beta instead of standard deviation as risk. Therefore, Treynor ratio is calculated by subtracting the risk-free rate from the average return of the investment, and then dividing this value with the investment’s beta.
How to use: Treynor ratio identifies investments that have better return to risk ratio. A higher Treynor ratio means that the investment had a better return and had less risk of getting that return.
Upside Capture Ratio
Definition: Upside Capture Ratio measures an investment manager’s ability to out-perform the index in up-markets.
How to use: Upside Capture Ratio is calculated by dividing the investment manager’s return by the return of the index in the up-market, and multiplying it by 100 to get a percentage. A value greater than 100 means the investment manager out-performed the index. A value below 100 means the investment manager under-performed compared to the index. A value of 160 specifies that the investment outperformed the index by 60% during the up-market. Thus, a higher number is better during an up-market.