Money market mutual funds invest in short-term, high-quality debt instruments, aiming to maintain a stable value.
Advantages include safety and stability due to high-credit-rating investments, high liquidity with typically penalty-free withdrawals, diversification across various debt instruments, and modest interest earnings.
Disadvantages encompass lower returns compared to riskier investments, lack of government insurance, vulnerability to inflation risk, management fees that can eat into returns, and the potential for negative yields in periods of extremely low or negative interest rates.
The Sterling Ratio is a risk-adjusted measure of return on an investment that focuses on downside volatility.
Calculation: (CAGR - Risk-free Rate) / Average of the Largest Annual Losses.
Advantages: Emphasizes potential for loss, focuses on larger losses, and provides a realistic view of performance by considering a risk-free rate.
Disadvantages: Heavily relies on historical data and might overemphasize the impact of outliers.
In practice: the 'Fund A' example with a 10-year CAGR of 15%, risk-free rate of 6%, and five worst drawdowns resulted in a Sterling Ratio of 0.90, indicating a good risk-reward trade-off.
Empirical evidence from India suggests that funds with higher Sterling Ratios tend to perform better during downturns.
Important note: Investment decisions should not be solely based on the Sterling Ratio, consider other factors and metrics.