The coronavirus pandemic led to a rout in the U.S. economy, ending its historic 11-year bull run in the first quarter of 2020. The U.S. economy contracted 4.8% at an annualized rate in the period between January and March for the first time since 2008. Economists believe that this was just a prelude to further upheaval in the days ahead, as they predict a contraction of about 37% in the next quarter, with consumer spending falling as much as 43%.
This is the biggest crisis America’s economy is going through since the Great Depression in 1930s. The U.S. economy had been growing steadily at a 2% annualized rate for 11 continuous years, before its run was cut short by the COVID-19 pandemic.
Amid such jittery conditions, mutual funds that are likely to offer steady returns along with a lower level of risk are popular choices. But to identify funds that can offer such encouraging features, one should find out a way of measuring a fund’s risk-adjusted return. This is where the Sharpe ratio comes into play. Created by Nobel laureate William F. Sharpe, the ratio is one of the popular ways of measuring funds’ performances on the basis of risk-adjusted return. A fund with a higher Sharpe ratio is believed to be more attractive than one with a lower ratio.
What Does Sharpe Ratio Mean for Mutual Funds?
The Sharpe ratio of a mutual fund measures its average return relative to the level of volatility it experiences. The ratio indicates the value that a fund delivers for the risk it poses, in other words, its risk-adjusted return. The numerator of the ratio consists of a fund’s mean return over a given time period subtracted by the return of a risk-free investment over the same period, say U.S. government Treasury bonds or bills. Meanwhile, its denominator comprises standard deviation of a fund’s return, which measures the level of fluctuation of returns, over the same time frame.
So, Sharpe Ratio = (Average Return - Risk Free Return)/Standard Deviation
This ratio indicates how much extra return one can derive from a portfolio by taking additional risk. It is generally speculated that Sharpe ratio calculated over a three-year or longer period of time should be considered while assessing the performance of a fund in terms of risk-adjusted return. We have already seen that higher the Sharpe ratio, the more will be the fund’s attractiveness among risk-averse investors. Moreover, most investors think mutual funds with a Sharpe ratio higher than 1 are good investment options.
3 Best Choices
We have, thus, selected three mutual funds carrying a Zacks Mutual Fund Rank #1 (Strong Buy) or 2 (Buy) that are poised to gain from such factors. Moreover, these funds have encouraging one and three-year returns. Additionally, the minimum initial investment is within $5000 and each of these funds has a three-year Sharpe ratio which is greater than 1.
We expect these funds to outperform their peers in the future. Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance, but also on the likely future success of the fund.
The question here is: why should investors consider mutual funds? Reduced transaction costs and diversification of portfolio without several commission charges that are associated with stock purchases are primarily why one should be parking money in mutual funds (read more: Mutual Funds: Advantages, Disadvantages, and How They Make Investors Money).
Fidelity Select Software & IT Services Portfolio FSCSX fund invests the majority of its assets in companies whose primary operations are related to software or information-based services. It primarily focuses on acquiring common stocks of both domestic and foreign companies.
This Zacks sector - Tech product has a history of positive total returns for more than 10 years. To see how this fund performed compared in its category, and other 1 and 2 Ranked Mutual Funds, please click here.
FSCSXhas a Zacks Mutual Fund Rank#1 and an annual expense ratio of 0.71%, which is below the category average of 1.29%. The fund has one and three-year returns of 13.8% and 21.1%, respectively. FSCSXhad a Sharpe ratio of 1.17 in the last three years.
Fidelity Advisor Series Growth Opportunities Fund FAOFX seeks growth of capital by investing primarily in common stocks. The fund invests in securities of only those companies which the Fidelity Management & Research Company (FMR) believes have above-average growth potential. FAOFX securities of both U.S. as well as non-U.S. based companies.
This Sector- Large Cap Growth product has a history of positive total returns for more than 10 years. To see how this fund performed compared in its category, and other 1 and 2 Ranked Mutual Funds, please click here.
FAOFXhas a Zacks Mutual Fund Rank#1 and an annual expense ratio of 0.01%, which is below the category average of 1.05%. The fund has one and three-year returns of 12.6% and 25.5%, respectively. FAOFX had a Sharpe ratio of 1.27 in the last three years.
Janus Henderson Global Technology and Innovation Fund Class T JAGTX fund invests a huge portion of its assets in equity securities of those companies that are expected to gain from improvements or advancements in technology. JAGTX seeks capital appreciation for the long run and invests in both domestic and foreign companies with stable growth potential. It generally invests in companies from different nations including the United States.
This Sector - Tech product has a history of positive total returns for over 10 years. To see how this fund performed compared in its category, and other 1 and 2 Ranked Mutual Funds, please click here.
JAGTX has a Zacks Mutual Fund Rank #1 and an annual expense ratio of 0.93%, which is below the category average of 1.29%. The fund has one and three-year returns of 14.1% and 21.8%, respectively. JAGTX had a Sharpe ratio of 1.18 in the last three years.
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