Many people choose the fund in which to invest by looking at the rankings / ratings. I have always held the view that ratings are backward looking and so it does not serve as serious tools for choosing a fund in which to invest.

It took some long conversations with some serious knowledgeable investors to understand what they did not understand! So here is an attempt :

a. Peer benchmarking is of no use for thematic funds: OMG this sounds like Greek? Hmm.. well if I run a Value fund I promise to deliver value over a long period of time – say 5-8 years. However the rating business happens on a far more regular basis (say monthly, i will not be surprised if they start doing it weekly – the software allows me to do that, you know? ). So on a week to week basis if you are going to compare my fund to some other fund, please do not invest in my fund. Examples of this are Templeton India Growth fund and Prudential India Discovery Fund. Over long periods of time they have delivered good value, but I do not know whether they have week on week or hour on hour remained a 5* fund.

b. A 5* fund means nothing! If I decide to club a few genres of funds, I will have say 200 ‘equity funds’. Now to be in the 5* category I need to be in the top 20 that is all. And as and when I keep adding to this big set, it becomes more and more easy to retain my 5* ranking.

c. Generally all funds immaterial of age and size are compared: Yes they do have a 2 or 3 year cut off so the very young funds do not fit into it, but still this is broadly true.

d. We keep reading again and again that the past is not a good indicator of the future, but still feel happy when we invest in a fund which is in the 5* category, hoping that it remains there forever the 20 years that we will stay invested. This is really funny.

e. If I create a fine enough sub group I can make sure that there are only 5 funds in one category: thus ensuring that the 5* category has only one player, permanently. Sounds mischievous? Not unthinkable, right?

f. Exactly the opposite of e is also true.

g. The rating agency is a very big beneficiary of the rating – the fund industry will happily use the rating and advertise it. Who benefits by the advertisement? the rating agency! Lol. This was so visible to us in the car industry a few years earlier – currently too many people rating cars, and too few people rating mutual funds. Sigh, alas.

h. The gap between the best fund and the second best is not even worth the effort taken to measure it!

……..will do a post on possible solutions…………

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  1. Subra Sir,

    Personally I think Share market is a 100% speculative business,where whatever you do is only different name calling for speculation,once you accept this fact,the explanations become very very simple & you can take expert advise on their face value (I mean @ zero value). So even when you invest in Mutual Fund what you are doing is only speculating through someone else, which helps in saying i did not screw up but someone else did which only helps your Ego & nothing else.
    there is very very nice article on this by sir John kay maybe I read it on your blog only sometime back just superb. The parable of OX which might answer most of the questions
    http://www.johnkay.com/2012/07/25/the-parable-of-the-ox

  2. Hello Subra sir,
    you said
    “Many people choose the fund in which to invest by looking at the rankings / ratings. I have always held the view that ratings are backward looking and so it does not serve as serious tools for choosing a fund in which to invest.”
    It goes against your earlier view of “Winners rotate. Losers stay the same.”

    Also, this post is particularly for mutual funds rating. For advice on investing in general, people can refer to http://www.subramoney.com/2011/10/investments-do-not-listen-to-your-parents/

  3. i can only write. People can choose how to interpret! Sanjay tell me from all that you have read wherever how will u use ratings for your investment decisions…

  4. I have been using star ratings of mutual funds by VROL for the past six years for investing. I have been investing by SIP after taking into consideration the fund house and manager, their returns over the past five years, whether they have consistently beaten their benchmarks, their portfolio holdings , alpha, beta, sharpe ratio and standard deviation. My MF portfolio included DSP BR Top 100, HDFC Equity, HDFC Equity, UTI Opportunities, Birla Sunlife Frontline Equity, IDFC Premier Equity and HDFC Midcap Opportunities fund. I stopped investment in Reliance Growth after its performance dropped but I am still in a profit of Rs 170000.
    These VROL and Morning Star ratings have helped me in getting a total annualised return of 12 to 19 % for all my MFs as of yesterday which beats putting your money in fixed deposits anyday. My take – Use these star ratings to separate the wheat from the chaff rather than invest in NFOs or other MFs which have no pedigree. It has stood me in good stead whatever anyone may say.

  5. Subra,
    Dont you think the same holds true for stocks also.(including your favourites).. The past performance of the company stock does not mean anything.But what we look for in the rating of mutual fund, the strength of fund manager,research team, processes followed,quality stocks in the portfolio….

    I Totally agree with Vinod.
    For the past few years, I am an avid reader of Valueresearchonline and this has maintained me in good stead.
    VROL and morning star can go a long way in helping you build a portfolio.

  6. Very interesting Subra sir, but if not ratings then what? How should we select mutual funds.

    The way I have been doing for last three years is to look at ratings. Next, I look at the past 3 year and 5 year returns. My criteria is amongst the top rankings in the category. Next I look at SIP returns in last 3 to 5 years, should have beaten inflation by 5% (depends on category). Next I look at the Fund strategy, the max and min allocation to debt and equity.

    Based on this, I invest using SIP. Is it the right approach?

  7. At least the ratings prevent the common man from choosing the dumb fund. But it’s also true that one should not read too much into it.

  8. @siddhant. why share market -everything we do in life is speculative.you study mba/ marry/buy a house/have a kid/start your business/read a blog – everything is based on the speculation that you are going to gain from it.nobody undertakes a speculative activity where loss is guaranteed -even smoking and drinking.(the smoker speculates he can get away with it).we shouldnt look down upon speculation.it is the lifeblood of an uncertain life

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