Mutual fund ratings – a media joke

If you read magazines, newspapers, etc. or watch the business channels you would have been convinced that people chase performance. Constantly ‘experts’ come on television and print media and say ‘people’ should not chase past performance. Actually articles and programs encourage people to churn or chase performance.

Do you know what a rating does? It rates past performance – very unlike a credit rating, which to some extent at least is forward looking.

However when I recently ran a screen on the best mutual funds over the past few years, I found something interesting. The fund returns (on an annualized basis) was 33.07%, 31.30%, 30.79%, 30.42%, and 29.66%.

Frankly what I am trying to say is you should not believe that old adage “Winner takes all”. Actually winner does not take all. In the long run whether you were in the fund which gave 33.07% or 31.30% for a period of 3 years, the overall money that you made would not have changed much. Also next quarter if both these funds gave (say) a return of 3% and 6% respectively the over all return figure may still be favoring the fund which got 33.07% over a longer period (!). What matters is what is the return over a 20-30-40 year period – on your total portfolio.Not just in one scheme. If you have 20% in equities and 80% in debt earning 8%, the total return on your portfolio will not reach double digits at ALL!

Let us take a poorly performing fund like Franklin India Prima fund would have given a return of 9% p.a. in its growth plan over a 4-5 year period. Though this number per se is a decent number, on a comparative basis it is lousy. However it is still better than a debt fund – how should you look at such a fund is your call, not the rating companies. You need to answer to your own head what is risk, how you want to look at it and how to deal with it. Do not try to create a portfolio for 30 years by listening to somebody for 30 seconds. It is not so simple. Know what to take and what to ignore when you are watching a program. IN economics / statistics this is called identifying the ‘noise’ in the data…

Thus those of you (or us) who keep shuffling funds or schemes should realize that sitting tight without worrying about returns over 1-3 quarters might be far, far better off than those who keep churning. Elsewhere I have called it a “rating trap” – which is helping on the rating company!

If you do like this post, thanks. However this thought is not original. Warren Buffet (frankly other than creating quotes what does he do in life, I do not know – somebody told me he is a businessman :)) says “Todays’ investor does not get paid for yesterday’s performance”. Even Mr. Peter Lynch says “Do not look at the rear view mirror and drive”.

Related Articles:

Post Footer automatically generated by Add Post Footer Plugin for wordpress.

3 Responses to “Mutual fund ratings – a media joke”

  1. Dr Mohammed Ali Khan on October 23rd, 2009 at 1:48 pm

    “Inactivity strikes us as intelligent behavior.” ~Warren Buffett

  2. Ravinder Makhaik on October 23rd, 2009 at 3:27 pm

    Then it implies that ‘Look before you leap’ is an meaningless caution out here

  3. Then, Subra, I wonder how I should choose between numerous funds available. I don’t look in the rear mirror and neither can I look ahead! How can a common investor solve this dilemna?

Leave a Reply

This blog is kept spam free by WP-SpamFree.