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Mutual funds use the same ratio, but it’s expressed as the average of all the individual P/Es of the stocks held within the fund. This figure can help you identify whether the fund is geared towards growth or value and how expensive it is compared to its peers. But aside from the P/E ratio, mutual funds have some specific fundamental qualifiers with which investors should be familiar.
This ratio can be used to determine whether a fund has “beaten” the market or not based on its risk parameters. It examines performance relative to the risk associated with the assets held in a portfolio. In other words, it will tell an investor whether a fund’s excess returns are a result of smart mangement decisions or simply a result of holding too much risk.
This ratio is a great comparative tool to see if a mutual fund truly outperformed the market based on the risk it took on or not. Imagine the S&P 500 gained 12% last year and the risk-free rate was 2% – the beta of the market is assumed to be 1. That gives it a Treynor ratio of 10%. Now take a mutual fund that returned 8% but its beta was only 0.5. That means the fund’s Treynor ratio is 12% thus beating the market from a risk-reward standpoint.
Putting it all together, comparing these ratios against other mutual funds will help you select the ideal one for your portfolio.
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