Mutual fund ratings are dynamic; opt for basket of investments
Mr Anand works for a company and to reduce his income tax liability, he wanted to invest in the Equity Linked Savings Scheme (ELSS). Instead of investing through a Mutual Fund advisor, he did his own ground work based on the ratings available.
During the beginning of this year he invested in Axis Long Term Equity Fund (G) and DSP Tax saver fund (G), as these had five star ratings from a reputed financial newspaper research team. But to his surprise now he has found out that the same research team has now reassigned three star rating to Axis Long Term Equity Fund (G) and four star rating to DSP Tax saver fund.
As the schemes have a lock-in period of three years, there is no way that he can change his investment. Every mutual fund comes in two versions – direct version and regular version. One of the key distinctions between them is that regular mutual funds have a distribution commission unlike direct mutual funds. This makes the expense ratio higher for regular funds. Hence, the return to the investor on direct investment may be more.
Generally, many investors go by the rating provided to different mutual fund schemes and invest under direct schemes. While making investment under direct equity, it is possible for any individual to depend on the fundamental factors of the company and also technical analysis available and one can select the company based on risk perception and return expectation. But coming to mutual fund schemes, though broad investment philosophy and benchmarking are available, there is no definite way to know the contour of investment in future.
Hence, individual investors depend on the ratings provided by different rating agencies. From the past experience, it seems that one can’t decide solely based on the ratings available.
Rating organisations like CRISIL, ICRA, CARE, and Value Research generally provide ratings for mutual fund schemes in India. There are business newspapers like the Hindu Business Line, which provide their own ratings based on their in-house research.
Rating methodology Mutual funds are rated mostly on the performance of the funds over different periods. The ratings also take into account the fundamentals of the fund houses, asset allocation of a scheme, the experience and credentials of a fund manager, returns based on inflation, besides several other parameters.
For example, CRISIL considers the following in its ranking methodology: Portfolio Concentration Analysis, Liquidity Analysis, Mean Return and Volatility Active Returns (the active returns are the percentage of loss or profits made by an investment portfolio as a result of active investment decisions by the fund manager).
Scales of one to five stars are decided on the basis of percentile in which the funds are placed in the order. Generally, five-star is assigned to top 10 per cent funds and the bottom 10 per cent is given one-star rating.
Any investment should be based on one’s risk bearing capacity. Higher the risk, higher will be the potential return on investment. In turn, mutual fund schemes can have different investment philosophies and different asset allocation based on the investors’ risk perception and return expectation.
As the mutual fund investment spreads to different stocks and debt instruments, there is no easy way to predict future performance. Rating is not an impediment for any fund to perform and it is always possible that poor-rated funds may perform better.
However, a poor rating may disturb the mobilisation for a particular Mutual fund scheme, and indirectly affect its working, as the mutual fund scheme may not have the advantage of size of investment and diversification.
(The author is a financial analyst.)