The universe of mutual funds in India is large and often leaves investors confused on what funds to go with. Understanding the fund strategy, their positioning, their risk profile, and applying these to their performance, become key factors in choosing a fund.
At FundsIndia Research, we look at all these factors, including qualitative assessments about the fund management, portfolio, and markets. These efforts are encapsulated in our Select Funds. The Select Funds list compresses the universe of funds into easy-to-understand buckets to allow investors to choose their funds without difficulty.
However, there are several funds which may not have made it to this list but have a performance record and are assessed by us. With a view to measure these funds in terms of their performance within their peer class, we have decided to rate all open-ended mutual funds that fall within our eligibility criteria. This article will discuss FundsIndia ratings, its methodology and how to use it.
What is FundsIndia Ratings
FundsIndia Ratings is a quantitative star-rating that considers risks, volatility, consistency, and past performance of a fund and assesses where a fund stands within its category. The factors considered to assess the funds are based on historic performance and does not in any way indicate the future potential of a fund.
With this set of ratings, investors would not only have our investment-worthy funds through our Select Funds list but also get an idea of where their other current holdings stand in relation to category peers.
Eligibility criteria for ratings
Equity and equity-oriented funds: For all equity funds except index funds, latest AUM should be above Rs. 100 crore and the fund should have at least a 3-year track record. Index funds and gold funds do not have an AUM criterion, but will have the inception criterion. There should be at least 5 funds making it past the eligibility criteria for the category to be rated.
In the case of sector/theme funds we have consciously refrained from rating them as different sectors perform well in different market phases and these need timing. However, in our select funds list we try and include a few sectors/themes when we have a favourable view on them. We also try and cover such themes in our weekly research reviews at the appropriate time. We have also chosen not to rate international funds as there are too divergent in their theme and lack comparable universe, in the Indian context.
Debt-oriented funds: For all debt-oriented funds, latest AUM should be above Rs. 100 crore and the fund should have at least a 3-year track record. There should be at least 5 funds making it past the eligibility criteria for the category to be rated.
Debt funds: The eligibility criteria varies depending on the category. For instance, for liquid, ultra short-term and other short-term debt funds the minimum track record is 2 years while it is 3 years for medium and long-term debt funds. Similarly, there exist stiff eligibility criteria in terms of AUM for short-term debt funds and less so for medium and long-term debt funds. A few others like gilt funds do not have an AUM eligibility criteria.
Equity funds: FundsIndia considers the proportion of large, mid and small-cap holdings of each fund to determine whether a fund falls in the large, mid or small-cap category. The market cap cut-offs for these are based on the maximum, minimum, and the average market capitalisations of the BSE 500 index, the BSE Mid-cap index and the BSE 100 index. Some funds may therefore fall into a different category after some quarters, if their average holdings based on the above consistently changes.
Debt funds: A combination of the portfolio’s average maturity, credit quality and fund’s defined category are considered to classify debt funds. For instance, liquid, ultra short-term and gilt funds are clearly defined as such in their offer documents and follow the stated strategy. These would be classified as per their Scheme Information document. However, there may be funds that predominantly follow a duration play and others that steadily invest in low credit instruments. We therefore use our own filters on duration and quality of credit and place the funds in the appropriate categories – whether income or dynamic bond or credit opportunity as the case may be. Such classification helps us compare a fund with right peers and thus assess them appropriately.
At present, the following categories of funds have been rated by us:
- Equity – large cap, mid cap, diversified, small cap, tax-saving, index, arbitrage
- Balanced/equity oriented funds including fund of funds and hybrid funds
- MIP/debt-oriented funds, including fund of funds and hybrid funds
- Gold funds
- Debt funds – liquid, ultra short term, short term, income, dynamic bond, credit opportunity, short-term gilt, long-term gilt
FundsIndia uses a range of quantitative parameters to arrive at a fund’s rating. In both debt and equity, we aim at assessing long-term performance, except for liquid funds which are short-term in nature. For other categories, we seek to avoid having ratings influenced by short-term movements.
In equity funds, the ratings assess their ability to be consistent, their control over volatility, and their ability to deliver returns for the risk taken. Towards this end, we use the following parameters:
|3-year daily rolling return against category for 5 years
|3-year daily rolling return against benchmark for 5 years
|1-year daily rolling return against category for 3 years
|1-year daily rolling return against benchmark for 3 years
|Sharpe ratio – daily rolling 1 year return over 3 years
|Standard deviation – daily rolling 1 year return over 3 years
|Downside protection - Sortino ratio, 1 year return over 3 years
|Average of daily rolling 3-year return for 5 years
|Average of daily rolling 1-year return for 3 years
|Nifty 500, the Nifty Midcap 100, Nifty 100, and the BSE Small-cap are the benchmark indices for the respective categories
In addition to the above, certain categories see different parameters. The large-cap exposure of balanced funds is also a factor we consider. In debt-oriented funds and arbitrage funds, the minimum daily return is taken to measure the fund’s ability to contain downsides as that is one of their roles. In the case of index and gold funds, the tracking error over daily rolling 1 and 3-year time frames as well as the expense ratio and fund size are considered.
Each of the above parameters receives individual weights based on our judgement on which of those have a higher impact on performance.
In the case of debt funds, given the starkly different characteristics of each category, we have different sets of parameters for each based on what is most suitable. Broadly, we look at the risk involved in terms of duration and credit risk, the return for the risk taken, and the control funds have on their volatility. Listed below are the broad factors considered.
|Mean 1-year return over the last 3 years
|Risk-adjusted returns (Sharpe) 1-year rolling over 3 years
|Risk-adjusted returns (Sharpe) 3 years rolling over 5 years
|Minimum 1-year rolling returns over the last 3 years
|% times negative returns when rolled daily for the last 5 years
|Yield to Maturity
|Standard deviation (volatility)
Each of the above parameters, to the extent they apply to a category, receives individual weights based on our judgement on which of those have a higher impact on performance.
We will review the ratings for all fund categories every quarter.
What will not be rated
- Sector and theme funds
- International funds
- All close-ended funds, including FMPs and Capital Protection Oriented schemes
- Interval schemes
- Funds that do not clear the eligibility criteria, including NFOs
Once the funds receive the weighted score, we use the following distribution to rate funds. This distribution helps reduce the skewness in the rating process and smoothen the rating curve.
|Distribution within category
How to interpret FundsIndia Rating
In the FundsIndia Ratings scale of 1 to 5, 1-star stands for lowest in terms of performance within the category, moving progressively higher with 5-star the highest. So funds rated as 5-star are the top 10% in that category in terms of performance at that point in time. The funds rated as 4-star are the next 25% of performers. Likewise, the 1-rated funds would be the bottom 10% going by performance. We would suggest that investors use the ratings as an indicator of how their fund is doing.
For investment decisions, we recommend that investors use our Select funds as a narrower option. It goes beyond mere quantitative factors and considers qualitative metrics that drive a fund’s performance. When you use the ratings to review your fund, if you find your fund having a rating of 2 or below consistently across couple of quarters, please talk to your FundsIndia advisor to understand the reason and whether you need to act.
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