Many people look at the ratings of a mutual fund before investing in them. This is what is the intention of the rating agencies! However they will tell you that ratings are backward looking (there is only Mercer which does forward looking ratings, but obviously available at a very high fee – which is fair enough).

Looking at ratings to invest in a mutual fund is pretty foolish. Also when the number of funds in a category increase, there will by definition be a lot of 5* funds. This is obvious is it not? If  I were running a rating agency and I decide that the top 10% will be called 5* it is good for the business. So if there are say 500 equity funds, you will have 50 funds that will get a 5* rating. Now how will you pick 2 funds (investing in more than 4 funds is a waste of time) given the fact that you have 50 funds from which to choose. However it is good for the rating agency – all the schemes will advertise, put an asterik and say ‘Subramoney has rated us 5*’ – clearly I will be the biggest beneficiary. L O L

Rating is a difficult business, done by overqualified people with impossible assumptions. Why they even rated many junk bonds as AAA, and then in 6 months down graded them to junk!

So does rating make sense? No. Not for mutual funds. For banks, company fixed deposits, etc. it may still make sense…but not for mutual funds. Frankly rating agencies should be above board, and above suspicion. Next big blunder will come from…?? Read on.

http://www.fool.com/investing/general/2010/05/21/put-the-rating-agencies-out-of-their-misery-before.aspx

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  1. Investors need help in choosing funds. Choosing from 500 funds is not easy. Its better to trust VRO’s ratings than to trust the Uncle Agents.

  2. – if you want to hire for your company from a college, wouldnt you restrict interviews to top 10% in terms of percentile, marks. Because it shows they have done well in current task so has potential to do well in future.

  3. So out of 500 funds should we choose 2 at random? 🙂

    Past performance inspires confidence for future, it does not ensure superior future performance. Anything we do in life is based on past performance – buying a car, house, electronics, choosing a school, college etc, we rely on past performance of the company or brand value. It still does not ensure that the product we buy is faultless but improves the chances of getting a good deal.

  4. Why do you say investing in more than 4 funds is a waste of time. Doesnt it make sense to have 2 funds per category (Large, Large & Mid, Mid & Small) for stability and higher returns? One can argue that one fund per category is enough, but then one cant always be right about the best fund in a category.

  5. Subra Sir

    Can you please disclose your 4 funds and its proportion. For lesser mortals like us until now the rear view mirror is the only available option..:)

    Thanks

    Shinu

  6. In case if you find a problem with rating, why do you recommend HDFC Top 200, Franklin Bluechip etc. in your blogs? Isn’t your decision also based on past performance? Then why bash these ratings? I don’t see a reason for this.

  7. S – if past performance inspires…future why do geniuses like us say ‘past performance is not an indicator of future performance?’

    Dilip: my brain is limited to 2 fund houses and one fund manager (which means if he leaves that fund, my money leaves that fund on that day). Out performed the index by a mile. Underperformed my own portfolio. NO, NOT willing to share fund managers names, but have done it many times in the past. Now praying for fund manager’s life. L O L

  8. Harish, I do not recommend any fund. Funnily, I am part of the history – have entered both these funds BEFORE THE TRACK record was created. L O L. Can afford a 3 year underperformance and still not bat an eyelid, thanks to the history. Nice to be a part of the history, na?

    So how i chose was NOT BECAUSE OF THE TRACK RECORD, but perhaps before Dhiren got so serious about rating @ valueresearch!

    I closely follow Dhiren as well as Morningstar, but using rating to buy a fund still rankles..your call though.

  9. Hi Subra,
    Then what is your advise to a small investor who does not have time & intention to study the market?

    Regards
    VB

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