Should you believe in mutual fund ratings?

Shashikant Singh
/ Categories: Mutual Fund
Should you believe in mutual fund ratings?

Most of the mutual fund investors invariably look into the rating of a fund provided by different agencies before deciding on investing in them. They also use it subsequently to make any changes in their portfolio and exit old funds or enter new funds. 

Rating gives an investor, a tool with which he can evaluate and compare the funds in their respective categories, with regard to its return and risk.

Issue of classification: The capital market regulator, Securities & Exchange Board of India (SEBI), has come out with the categorisation and rationalisation of mutual funds schemes in 2017. This has helped the investors in a great way to know about the funds before investing in them. Nonetheless, the style issue remains unresolved. In a given category, different funds might be following different strategies such as ‘growth’ and ‘value’ and hence, cannot be categorised as one. Although some agencies follow a particular style yet in order to describe a fund’s style as per the assets it consists of, the portfolio composition should be known not only in the beginning but also, throughout the analysis period, thereby, making the comparison tough.

Risk-adjusted return: For most of the rating agencies, the risk-adjusted measure remains the core of fund ratings. This is measured in its category and its average. However, within the category, funds have different weightage and cap, and thus, generating risk and returns, might not be comparable. For example, in the multi-cap fund category, a fund might have performed better in 2018-19, if it was large-cap biased. This might change now. Besides this, there are some ratios that are calculated and dependent upon the selection of index as a benchmark. The polarisation of the stock market recently in the Indian equity market will lead to different ratios within a category. For example, a large-cap fund that is benchmarked to Nifty 50 will have a different ‘information ratio’ if the same fund had been benchmarked to Sensex or Nifty 100.   

Historically, we have seen that the rating systems that are prevalent right now, acts more as an appraisal of the past results. This hardly helps an investor to make profitable investment decisions. To make it worthy, the rating agencies should choose a new measure of returns and risk to make it useful for the investors.

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