In a report titled Not all Risk Measures are Created Equal, Morningstar said investors need to understand that not all risk measures “work in the same way”.
“No one fund metric can tell you everything you need to know before deciding whether to buy, hold, or sell a fund,” Morningstar said.
“But looking at risk in various ways can help lead you to a clearer conclusion,” the report said.
Morningstar pointed out that two metrics investors should consider when measuring fund risk are downside capture ratio and standard deviation, since both are “very useful measures of risk”.
“Downside capture ratio measures how a fund has performed during market declines. It does this by calculating the extent to which the fund’s performance mirrored that of its benchmark during months in which the benchmark lost ground,” Morningstar said.
“In contrast with downside capture ratio, standard deviation does not compare a fund with its benchmark. Rather, it measures the volatility of the fund’s own performance over a given period,” the report said.
“Technically, a fund’s standard deviation reflects how far a fund’s performance strayed from its overall average over a given period.”
Morningstar also said the reason why standard deviation is an important measure to use when evaluating risk is because it can predict the nature of a fund.
“Another reason to pay attention to standard deviation is that funds that are more volatile are often harder to own – that is, to hold on to through thick and thin – than those that are less volatile,” Morningstar said.
