Distributors should do their own due diligence and not merely
recommend top-rated funds.
Though a five-star rating
might help pull in investors, ratings/rankings cannot be the sole criteria to
recommend a fund.
“A five-star rating for a
fund means that it has a good historical track record as compared to its peers.
Distributors first need to choose a list of five-star rated funds and then do
their own due diligence. A five-star rating is not a buy call. We had done an
analysis which showed that
five-star rated funds attracted more inflows than others. Other parameters like
the fund house, its best practises and compliance also play a very vital role. Our
study shows that 60% of
five-star rated funds have carried forward their performance in the future as
well. However, there is no guarantee that such funds will continue to perform
well,” says Aditya Agarwal, Managing Director, Morningstar India.
Ratings are like ranks
given to students who score well in exams. However, it’s not necessary that the
student will continue to score well in the future. The case is similar with
five-star rated funds. Ratings act as a first filter for shortlisting a fund.
Mukund Sheshadri of MS Ventures
Financial Planners observes that a few funds have lost their star ratings due
to bad performance. “One should first look at the risk-taking ability of the
investor and not just the star rating. After shortlisting top-rated funds, you
should look at the category of the fund, its standard deviation, Sharpe ratio, alpha
and AUM. Ratings reflect past performance. Funds can lose five-star ratings if
their performance slips. This has happened in some cases. A micro-cap fund with
a five-star rating can’t be recommended to an investor having low risk
appetite. You can take risks with surplus money but you can’t take risks with
money which is attached to a goal.”
There are a few who believe
that ratings do not matter as far as mutual funds are concerned. “Ratings are
relevant in company fixed deposits and not so much in mutual funds. Ratings
don’t hold much significance,” says a Mumbai-based advisor.
are funds rated?
Funds are assigned stars on
the basis of their performance across time periods. Funds with higher returns
are assigned more stars and vice-versa, as compared to their peers in the same
category. Each rating agency follows its own rating methodology. Consistency of
performance, alpha, standard deviation and Sharpe ratio are some factors which
are taken into consideration before tagging a fund. However, these are just
quantitative filters. Rating agency Morningstar’s ratings take into account qualitative
Advisors should also do
their due diligence on the fund. Some of the things they would do well to
of performance – it is important that the returns are not just an outcome of a
recent surge in performance
of fund to client and its role in the client portfolio – Each fund should have
a logic for featuring in the client’s portfolio
Manager’s track record - How are the other funds being managed by this fund
and systems of the fund house – Superior fund performance should ideally be an
outcome of fund manager’s skills combined with robust investment processes and
you recommend star rated funds? What other parameters do you look at while
recommending funds to your clients? Tell us.