Same Return, Different Risk - and a Benchmark That Flatters
Two equity funds show an identical 14% five-year CAGR. Fund A: standard deviation 18%, beta 1.05, maximum drawdown 42%, Sharpe ratio 0.62. Fund B: standard deviation 12%, beta 0.75, maximum drawdown 24%, Sharpe ratio 0.78. Fund B's stated benchmark is the Nifty 100 TRI, but about 30% of its portfolio is in mid- and small-caps, and its largest holding is 11.5% of NAV. Fund A's advertisement sets out its 46% one-year return in large type and shows the one-, three- and five-year figures and the benchmark only on the last slide in small print. A client with a five-year horizon, moderate risk tolerance and ₹20 lakh to invest is choosing between them.
1. Which risk-adjusted comparison is meaningful, and what should the client be told about Fund B's benchmark?
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Equal CAGR with unequal volatility means the two funds took very different paths to the same place. Fund B delivered the same return with two-thirds of the volatility and a drawdown of 24% against 42% - for a moderate-risk client, that is the better portfolio unless they can genuinely sit through a 42% fall.
What to compare:
- Sharpe ratio (0.78 vs 0.62) supports B, but Sharpe penalises upside and downside equally; add downside deviation or Sortino, and downside capture.
- Beta 0.75 tells only part of the story: a beta measured against the Nifty 100 understates the true risk of a portfolio with 30% mid- and small-caps, and small-caps carry liquidity and tail risk that monthly beta does not capture.
- Information ratio and alpha should be computed against a blended benchmark (roughly 70% Nifty 100 TRI + 30% mid/small-cap index). Against the stated Nifty 100, any alpha is inflated and the comparison is not apples to apples.
The judgement: B is likely suitable, but its outperformance must be re-measured on the right yardstick, and the client should be told the benchmark misstates the risk being taken.
2. Assess the advertisement against mutual fund disclosure norms.
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The advertisement is selective and therefore misleading, even though each number may be true.
What compliant performance communication requires:
- Standardised point-to-point returns for 1, 3 and 5 years and since inception, with CAGR used for periods over one year, all as of the same date.
- The scheme's benchmark shown alongside, so the reader can see whether the return came from the market or the manager.
- Prominent, legible placement of the standard warning that past performance is not indicative of future results, along with scheme name, category and riskometer.
- No cherry-picking of a favourable window; the one-year figure cannot dominate the page while the longer, less flattering record is buried.
Practical advice to the client: judge a fund on rolling returns and consistency across market cycles, not on one year, and treat any advertisement that leads with a single figure as marketing rather than evidence.
3. The largest holding at 11.5% of NAV - what is the regulatory position, and what is the judgement call?
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Regulatory position: an open-ended equity scheme may not invest more than 10% of NAV in a single security. It may go to 12% only with prior approval of the trustees and the AMC's board, backed by recorded justification. There are also aggregate prudential limits at the AMC level. So 11.5% is not automatically a breach - but it is only permitted inside that approved band, and it must be evidenced in the compliance file, not discovered after the fact.
The judgement call: a stock above 10% of the portfolio concentrates idiosyncratic risk that the client is not being paid to take, and it magnifies the gap between the fund's stated diversification and its real behaviour. Check (a) whether board and trustee approval exists, (b) whether the position is a deliberate high-conviction holding or has drifted above the cap because the stock ran up - drift must be corrected within the prescribed window, (c) whether it overlaps with the client's other holdings, and (d) whether the fund's riskometer and factsheet disclosures still match how it is actually run. For a moderate-risk client, an 11.5% single-stock exposure is an argument to size the fund smaller, not to reject it outright.