R-squared (R²) measures how much of a fund or stock’s return movement can be explained by its benchmark index. Values range from 0 to 1 (or 0% to 100%) — the higher the R², the more the portfolio behaves like its benchmark.
Formula: R² = (Correlation of fund vs benchmark)² × 100
INR example: A large-cap mutual fund with R² = 0.95 vs Nifty 50 means 95% of its return variance is explained by Nifty — effectively closet-indexing. A flexicap with R² = 0.70 has more active deviation. For Alpha and Beta to be statistically meaningful, R² should typically be > 0.70.
When to use: Always check R² before trusting Alpha or Beta. A fund with R² < 0.50 vs its benchmark is being compared to the wrong yardstick — the Alpha number is noise.
SEBI note: R² is computed on 3-yr monthly returns per SEBI’s Scheme Information Document standards. Past R² does not predict future tracking behavior.
Related terms: Beta, Alpha, Tracking Error.