R-squared is a statistical value which is used to find out how correlated a Mutual Fund is with its Benchmark.the R-squared is used to check the reliability of BETA of the Mutual Fund.
Meaning of R-squared
R-squared shows the relationship of a Mutual Fund with its benchmark.It does not tell about the quality of a Mutual Fund, rather how the Mutual Fund behaves in relation to its benchmark. It’s measured in percentage. An index fund is supposed to have an R-squared of 100% or close to it. It can be deducted that a Mutual Fund having R-squared as 70% follows its benchmark more closely that another with 55%.
Use of R-squared for the investor.
To have a general guidance, 70% or higher R-squared for a Mutual Fund is good. The BETA of Mutual Fund becomes useful only when it has high R-squared. therefore it can be said R-squared substantiates BETA of Mutual Fund.
As an investor, while selecting a mutual fund for investment, look at its R-squared value and read it along with BETA. It can be said that generally when the R-squared is 80% or more for a Mutual Fund, its BETA is reliable. Finally, R-squared is just one parameter amongst many that need to be taken into account while doing investment in Mutual Fund.