It is commonplace for fund houses to flaunt the number of stars/points their funds have garnered. In turn, the same is utilised by distributors and agents alike to convince investors about merits of the fund. There is nothing wrong with the idea of granting rankings/ratings to mutual funds. However, we believe that the degree of reliance and the utility they offer is certainly worth a debate. Our concerns regarding rankings and ratings stem from two reasons.
Firstly, the method of computing rankings/ratings tends to be largely quantitative. The norm is that risk-adjusted returns (i.e. returns clocked by a fund vis-à-vis a risk-free investment avenue) and performance vis-à-vis similar funds are the factors considered.
Qualitative factors like the fund management team's skill sets and the processes followed by the fund house are never factored in. Similarly, fund-specific features like the portfolio management style or adherence to the stated investment style are not considered in the rankings/ratings process either.
In effect, we could have a diversified equity fund which is positioned to invest in large cap stocks, breach its mandate and invest in mid cap stocks instead, when the latter witness an upsurge. So long as the fund performs on the stated return parameters (i.e. risk-adjusted return and performance vis-a-vis peers), it can feature as a top-rated fund. Should investors invest in a fund which fails to adhere to its stated investment mandate? We think not! But the rankings/ratings do suggest otherwise.
Also what rankings/ratings fail to provide is an outlook on the fund. Admittedly, forecasting with precision how a fund will perform going forward is no cakewalk. But the fund's portfolio management style till date may at times provide indications of how it is likely to perform in various scenarios.
For example, a fund which typically holds a significant portion of its portfolio in cash is likely to lag its fully invested peers, when markets rise sharply. Conversely, when markets correct sharply, the given fund should ideally suffer less than its peers. Rankings/ratings based solely on historic net asset value performance fail to reveal such vital aspects of a fund's performance.
Secondly, rankings and ratings fail to tell investors what they should do. For example, a diversified equity fund, powered by a strong showing, might feature as a top rated fund. But how should investors figure out, if they should be adding the fund to their portfolios.
By virtue of the top billing that the fund has earned, does the fund become suitable to be a part of every investor's portfolio? In the above case, the fund could make an apt fit in a risk-taking investor's portfolio; but can the same be said for a moderate risk-taking investor, who is a couple of years away from retirement?
In some ways, rankings and ratings, subscribe to the "one size fits all" approach. They seem to suggest that if a fund has earned a top-notch position, investors across categories can invest in the same.
At Personalfn, we have always held that investing and financial planning are personalised activities. Hence, a fund could be right for a given investor and (despite its sterling performance) be completely unsuitable for another.
We believe that rankings and ratings when considered in isolation can add little value to investors. They could perhaps serve as starting points for identifying a broader set of "investment-worthy" funds; but investing in a fund, based solely on number of stars against its name may not be the right move. Instead, investors need the services of a qualified and experienced financial planner, who can help select funds that are right for them.
Another outcome of rankings and ratings is seen at the various "awards" functions in the mutual funds space. Funds with more stars and higher ranks inevitably get chosen as "winners" in their respective categories. What's been our experience at Personalfn with respect to the schemes we tend to recommend and their getting awards? Well, a few months back a leading business channel organised an awards function for the best performing mutual funds.
In about 95 per cent of the categories, winners were schemes from just two fund houses - all of which do not figure in our recommended lists presently. Were we disappointed? Hell, no! Incidentally post the awards, some ex-fund managers from one of these two fund houses were under investigation for having made a dubious investment in a technology company on a preferential basis in Year 2000 (the Ketan Parekh days).
And as far as the other fund house is concerned, we have a "No View" - if you are our client, you know what we are referring to. Are our clients losing out by not investing in these two fund houses? No way! Our clients remain on course to achieve their financial goals. And, importantly, our clients' portfolios consist of very solid schemes from credible fund houses. So why take on any additional risk to meet their goals.
Our advice - don't follow the stars blindly; at least not while investing in the mutual funds segment.
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