Sandip Sabharwal - Uncategorized - MIRROR MIRROR ON THE WALL……….

Who’s the fairest of them all ?

I just cannot help but notice that the maximum numbers of hoardings these days on the Mumbai skyline are occupied by advertisements of a particular industry. A year back most of the hoardings were dominated by Real Estate companies and six months prior to that by companies looking to raise funds in the stock markets by doing IPO’s. Currently these hoardings are dominated by ads of various Mutual Fund houses. A number of these are of the best performing fund house or are advertising the awards received by them for some of their funds across various categories of debt and equity. Even a professional like me who has spent more than 14 years in the Mutual Fund Industry is totally confused by this. (So, my guess is that retail investors will be totally and completely confused as to who is actually the fairest of them all).

I think the main reason for this is that there are multiple agencies rating Mutual Funds today and each one of them has their own criteria. As such the degree of commonality in the awards given by one agency to the other varies a lot. Today Mutual Fund awards are given by CRISIL, ICRA, LIPPER and MORNINGSTAR. Besides this Valueresearch also has its own rating criteria which is very popular with investors, distributors and Fund Management companies. (Valueresearch’s 5 star rating is very widely advertised)

It has today become just like the film industry where initially there was just the Filmfare awards and then over the last 10 years Star Screen, Zee Cine, etc. etc. have also started. IIFA awards have also become very popular these days.

Each one of these companies giving awards or rating funds not only have their own criteria of judging funds but also have different time scales on which funds are ranked.

CRISIL for example ranks most equity and long term debt funds on a two year performance track record with different weightages given to the immediately preceding six months and to three following six month periods. For equity funds it gives weightage to company and industry concentration, liquidity of the portfolio etc. awards are given to the top 10% performing funds in each category. In the current year it has also introduced some new awards for funds which have done well consistently over a period of time. Here the criterion for the same is not known to me.CRISIL also has an award for Fund House of the year.
ICRA gives awards to funds based on some risk adjusted return parameters. However it gives awards over one and three year time periods. This is totally different from the CRISIL awards where it is two years. The category of funds is also very different from CRISIL’s. It gives some 7 star, 5 star etc awards.
Valueresearch has a totally quantitative model of rating funds and it requires the fund to be in existence for at least three years before rating it. As such some funds which might be new and do well for less than three years do not get ranked. In the valueresearch model returns and volatility are mainly considered and they do not actually go into portfolio analysis like CRISIL. In the valueresearch model it rates funds from 5 to 1 star (best to worst). Here funds move into each category slowly and move out also slowly.
LIPPER gives awards over 3, 5 and 10 years. Here consistent returns over these time periods are given awards. Funds here are ranked from on a scale of 1 to 5. The criteria followed by LIPPER are quite different from the others and it also requires a minimum history of 3 years.
MORNINGSTAR which has just started operations in India gives awards to funds on their risk adjusted returns over a three year time period. Here the numbers of awards given out are the least among all the rating agencies. (Maybe making it more credible).

In most of these fund awards although it is still possible to figure out how individual fund awards are given, it has been an enigma to me how the overall Fund House Awards are calculated. The averaging methodology of each award giving institution is quite different.

Now given the fact that different awards are given on not only different time periods but also on different criteria, it creates a huge list of funds getting awards. So, how does an investor make an informed judgment (as no investor will have the time to looks at the methodology of fund ranking to understand it)?

Moreover these fund awards do not take into account qualitative changes that can happen in a fund house into account and are passed on past data rather than future outlook (and frankly there is no way to do that also). For example strongly invested portfolios typically have the ability to do well even 6-12 months after the fund manger who is handling that fund has left and it is taken over by another fund manager. A fund house in which I worked in the past got an advantage of this even one year after I had quit and won a Best Fund House award as they largely retained the same portfolios for a period of time. Similarly I remember that some of the key picks of a well know fund manger who currently operates out of Singapore did so well after he left that they drove the performance for his erstwhile funds over a period of several quarters as some of them became big multibaggers. As such management or fund management changes also become very important 2-3 quarters later.

As one very famous investor has said – “The investor of today does not profit from yesterday’s growth “.

I believe that one solution is that Association of Mutual Funds (AMFI) in consultation with all fund houses should come out with its own ranking methodology and carry out the ranking exercise once a year. These could become the most credible awards over a period of time.

I would like this article to become an interactive forum for readers to share their views. As such other constructive suggestions can be helpful.

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