PrimeInvestor ratings – how we rate funds and why we’re different

Share on whatsapp
Share via Whatsapp
Share on twitter
Tweet it out
Share on facebook
Share on FB
Share on linkedin
Post on LinkedIn

Fund ratings, at a glance, tell you a little about the history of a fund. For many of you it’s a quick reference on whether a fund is a good one or not. PrimeRatings (Free registration required to access) is a mutual fund rating system. But it’s not simply yet another fund rating tagging on to the list of ratings that are already available. PrimeRatings’ methodology:

  • uses a more diverse combination of risk and return metrics,
  • looks at fund categories based on their characteristics and investment purpose and not just their SEBI-defined category,
  • spreads ratings out into a smoother curve which provides better distinction between funds and circumvents the problem of a sharp jump or fall in ratings

Here’s a look into our ratings process and how we’re different.

Being selective

Not all funds are rated. Funds must meet two basic requirements: AUM and age. The cut-offs depend on the type of fund. Equity funds, for example, need a minimum 3-year timeframe of existence and an AUM of Rs 100 crore before we rate them. Index funds have a lower AUM requirement. Liquid and ultra short term funds have a far higher AUM cut-off at Rs 1,000 crore and Rs 500 crore, but have a shorter timeframe.

We have different age and AUM cut-offs because each fund type is different. Liquid and other very short-term funds certainly don’t need a long history as their nature allows us to judge performance quickly. But given their high institutional interest, a large AUM is more prudent. Equity funds, on the other hand, need a longer timeframe to judge performance but can manage deftly even in smaller AUMs.

The next eligibility criteria is the category. Sector and themed funds are not rated – themes and sectors are tactical calls. Rating these funds as 5-star or 1-star serves no purpose. One, it doesn’t shed light on the potential of a theme. Two, it can additionally mislead you into thinking a fund is good simply because it holds a high rating.

We also don’t rate categories where the number of funds are too few to show meaningful results, such as multi-asset allocation funds, US-based funds, or emerging market global funds. We don’t rate closed-end funds.

Different rating system

PrimeRatings use half-star ratings progressions in the 1 to 5 star range. That is, it’s not a simple 5-4-3-2-1 star rating system but a more graded 5★ to 4.5★ to 4★ to 3.5★ and so on until 1★. This is a key metric on which we stand apart.

There are two reasons for adopting this methodology. Firstly, it provides better distinction between fund performances. This holds especially true in categories that have several funds. When a single rating houses a large number of funds, there often is a distinct difference among the funds. For instance, consider the equity multicap category. A Kotak Standard Multicap could be rated 4★ star and so could Aditya Birla Sun Life Equity. However, the Kotak fund fares much better on all metrics. A 4.5 rating for the Kotak fund would establish this superior performance.

Secondly, it provides a more gradual shift in ratings when fund performances change. For instance, let’s say a 3★ fund begins to pick up. Instead of it jumping straight to 4, the up-move is more gradual to a 3.5★ and then to a 4★ if performance sustains. This offers a more realistic measure of a fund’s performance than a quick rating improvement. The same holds when a fund begins to falter in performance – moving from, say, 3 to a 2.5 and then to a 2 instead of a precipitous drop from 3★ to 2★.

This is important because each rating has attached to it a certain implicit understanding. A sharp rating climb or drop can be misleading in terms of understanding a fund’s performance.

Comparing it right

The second way we stand apart from other fund rating providers is the way we club similar categories and then rate them. This gives a truer picture of a fund’s performance and is far stricter than sticking to SEBI-defined categories. SEBI’s categories in both debt and equity have overlaps in terms of their characteristics and the role they play in your portfolio.

For example, there is limited distinction between a low duration fund and an ultra short duration fund. Both funds serve a 3-12 month holding timeframe. Both invest in money market instruments such as commercial papers and certificate of deposits. Both have similar return and maturity profiles. As an investor, your choice for a less than 1-year timeframe would encompass both categories. Similarly, there are several overlaps between corporate bond funds and medium duration funds in credit risk and/or maturity. The choice isn’t between categories, it is between funds that do the same thing.

Consider equity funds. A multicap equity fund could follow a value strategy. A value equity fund could be multicap in nature. A focused fund could either be large-cap oriented or multi-cap. A large-cap fund could follow a focused strategy.

Therefore, to get the true picture of a fund’s performance, these need to be compared correctly. In PrimeRatings, we put and rate comparable categories together. This ensures that funds aren’t advantaged or disadvantaged and that you have the right picture when you look at ratings. Other rating agencies do not have this approach.

Tailoring metrics

The third way we stand apart is the scoring system itself. We tailor metrics and weights for each category depending on the characteristics of that category. Using a set of metrics uniformly across equity funds, debt funds, and hybrid funds as other rating agencies do fail to consider the uniqueness of each category. Our experience in analysing fund performance over the years also shows us that each fund category is developing very differently in terms of potential, performance, and risk. They therefore need to be rated distinctly.

For example, for large-cap funds the ability to beat benchmarks across market cycles carries a higher weight as it gets increasingly tough for them to do better. For small-cap funds, however, benchmark beating is not very difficult.

In dynamic bond funds, performance across rate cycles showcases their ability to alter their portfolios to capture opportunities much more than just looking at returns. In categories where there can be vast differential in credit risks, metrics need to take such risks into account. Expense ratios are a key return differentiator in some categories but not in others.

Metrics we use also strike a balance between looking at longer term performance and recent performance. This way, the ratings do not consider data that may have turned irrelevant nor is completely swayed by recent performance.

We suggest you use ratings as an indicator as to how your fund is doing. While we address risks and returns in our rating methodology, do bear in mind that these are based purely on historical returns. While our ratings may showcase trends of turnaround or dip in performances better than others, it is not a prediction for future performance. Qualitative assessments are required in addition to quantitative metrics to make an investment or exit call. Those are considered in our fund recommendations, which will be available once we go live.

Look out for our philosophy on our other researched products soon. If you’ve not read our first one on fixed deposits in this series, here it is:

https://www.primeinvestor.in/2019/11/29/what-we-look-for-in-fds-the-primeinvestor-approach/

How to read our ratings

Based on metrics and weights, each fund has a score. The scores are rated on a curve in the  distribution as in the table below.

In the below scale, 1★ indicates the lowest in terms of relative performance within the rated set, moving gradually higher to 5★. For example, 5★ funds are those in the top 5% in terms of score for the rated period. We update PrimeRatings every quarter.

File could not be opened. Check the file's permissions to make sure it's readable by your server.
Share on whatsapp
Share via Whatsapp
Share on twitter
Tweet it out
Share on facebook
Share on FB
Share on linkedin
Post on LinkedIn

Please note that any specific queries on any of our recommendations will be answered ONLY through email. If you are a subscriber, please mail [email protected].  Only general queries or discussions will be answered through the comment section of the blog. For full details, please refer to this post – How to communicate with PrimeInvestor.

18 thoughts on “PrimeInvestor ratings – how we rate funds and why we’re different”

  1. In your recent article on hybrid conservative, icici pru savings fund was considered riskier as it has more than 50% AA rated instruments. But you had rated 5 star for the same. Bit confused on the judgement

    1. Hello sir,

      Ratings consider a variety of metrics. Credit risk is one among them. However, ratings are also relative, i.e., a fund is rated compared to others in its category. As we also noted in that article, ICICI Pru is the most consistent performer in its category and its returns are strong. Therefore, its relative score is good which reflects in its rating.

      Now, having credit risk doesn’t automatically make a fund bad. It makes it unsuitable for a short-term timeframe which is why we avoid such funds. A high credit risk may not necessarily push the fund to, say, a 1 star rating provided it does very well on other metrics such as volatility and consistency. This is a good example why one shouldn’t go by ratings alone to decide which funds are good and not, because numbers can mask risks.

      Thanks,
      Bhavana

    1. Thanks for your interest in our service! We’ll be launching the beta version of our service on 15 Jan. And yes, it is well within reach of average investors. Our aim is to make our research widely accessible.

      Thanks,
      Bhavana

  2. Hi,
    A couple of questions:
    a) Will you also show the ratings over a period of time? Eg, if a fund moves from 5* to 3* over 2 years, can we see the trend of ratings?
    b) How do you plan to assess fund manager change impact on ratings?
    c) How do you factor in fund size into the ratings?
    d) Some funds are far more transparent about their philosophy and have skin in the game (eg. Parag Parikh, DSP to some extent). Would you factor this in?
    d) For ratings changes, will you publish separately – in a way that’s actionable – ie. not give all the ratings changes (too long a list), but give ratings changes for the top funds, where the ratings are significantly different. This gets challenging to do, but will add value.
    e) One more question (which I’d asked earlier but perhaps have missed the response) – how is what you do different from what the current FundsIndia team does, in terms of methodology? They are also supposed to review the ratings periodically.
    f) Is your methodology quantitative? Or not? There’s no gray area here I believe!! Either the quarterly reviews have human input (humongous work), or they don’t.

    Good luck to the team, and looking forward to good quality work from you guys!
    K.

    1. Hi,

      No, we’re not planning to show trends in ratings, at this time at least. I do see your points on highlighting rating changes and trends; it’s great suggestion, thanks! We’ll see how we can implement it.

      Fund manager changes are not a factor we take into ratings because it’s not quantifiable. The rating system is entirely quantitative. Any impact a fund manager change has on the fund will show up in performance later and this will affect its rating. The point is, a manager change may not be eventful in some funds while for others, it could be. To give a prospective call on this – before seeing impact, I mean – would be qualitative as it goes into understanding the role of the manager, the fund’s strategies, the AMC’s processes, and the fund. Similarly, transparency, skin in the game etc are qualitative – it’s not possible to assign a score to it. All these factors, and more, come into play when we draw up our fund recommendations. These recommendations and portfolios will be out soon.

      Fund size is factor in some categories where it can make a difference, and is a gating criteria for all categories. As for your question on methodology, the different metrics/criteria we use for ratings, the weights, the grading system on the score etc have all been refined further and more tailored to each category that we rate.

      Hope this answers your questions! Thanks for your support and suggestions,

      Bhavana

Leave a Comment

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.

Register for FREE!

Gain instant access to more PrimeInvestor articles, researched products, and portfolios

The essence of PrimeInvestor

Register for FREE!

Gain instant access to more PrimeInvestor articles, researched products, and portfolios

Legal Disclaimer : Redwood Research (with brand name PrimeInvestor) is an independent research entity offering research services on personal finance products to customers. We are a SEBI registered Research Analyst (Registration: INH200007478). The content and reports generated by the entity does not constitute or is not intended to constitute an offer to buy or sell, or a solicitation to an offer to buy or sell financial products, units or securities. All content and information is provided on an ‘As Is’ basis by PrimeInvestor. Information herein is believed to be reliable but PrimeInvestor does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. The services rendered by PrimeInvestor are on a best effort basis. PrimeInvestor does not assure or guarantee the user any minimum or fixed returns. PrimeInvestor or any of its officers, directors, partners, employees, agents, subsidiaries, affiliates or business associates will not liable for any losses, cost of damage incurred consequent upon relying on investment information, research opinions or advice or any other material/information whatsoever on the web site, reports, mails or notifications issued by PrimeInvestor or any other agency appointed/authorised by PrimeInvestor. Use of the above-said information is at the user’s own risk. The user must make his own investment decisions based on his specific investment objective and financial position and using such independent advisors as he believes necessary. All intellectual property rights emerging from this website, blog, and investment solutions are and shall remain with PrimeInvestor. All material made available is meant for the user’s personal use and such user shall not resell, copy, or redistribute the newsletter or any part of it, or use it for any commercial purpose. PrimeInvestor, or any of its officers, directors, employees, or subsidiaries have not received any compensation/ benefits whether monetary or in kind, from the AMC, company, government, bank or any other product manufacturer or third party, whose products are the subject of its research or investment information. The performance data quoted represents past performance and does not guarantee future results. Investing in financial products involves risk. Mutual Fund Investments are subject to market risk, read all scheme related documents carefully. As a condition to accessing PrimeInvestor’s content and website, you agree to our Terms and Conditions of Use, available here. This service is not directed for access or use by anyone in a country, especially, USA, Canada or the European Union countries, where such use or access is unlawful or which may subject Redwood Research or its affiliates to any registration or licensing requirement.

• Aditya Birla Mutual Fund • Axis Mutual Fund • Baroda Mutual Fund • BNP Paribas Mutual Fund • BOI AXA Mutual Funds • Canara Robeco Mutual Fund • DSP Mutual Fund • Edelweiss Mutual Fund • Essel Mutual Fund • Franklin Templeton Mutual Fund • HDFC Mutual Fund • HSBC Mutual Fund • ICICI Mutual Fund • IDBI Mutual Fund • IDFC Mutual Fund • IIFL Mutual Fund • Indiabulls Mutual Fund • Invesco Mutual Fund • ITI Mutual Fund • Kotak Mahindra Mutual Fund • L&T Mutual Fund • LIC Mutual Fund • Mahindra Mutual Fund • Mirae Asset Mutual Fund • Motilal Oswal Mutual Fund • Nippon India Mutual Fund • PGIM Mutual Fund • PPFAS Mutual Fund • Principal Mutual Fund • Quant Mutual Fund • Quantum Mutual Fund • Sahara Mutual Fund • SBI Mutual Fund • Shriram Mutual Fund • Sundaram Mutual Fund • Tata Mutual Funds • Taurus Mutual Funds • Union Mutual Funds • UTI Mutual Funds • Yes Mutual Funds

Equity: Large Cap Funds | Mip Cap Funds | Large And Mid Cap Funds | Small Cap Mutual Funds | Contra Mutual Funds | Dividend Yield | Focused Mutual Funds | Find Top Index Funds | Best Sector Funds | Thematic Mutual Fund | Best Value Mutual Funds | Equity Linked Savings Scheme | Tax Saving Funds
Debt: Banking And PSU Funds | Corporate Bond Funds | Credit Risk Funds Mutual Funds | Dynamic Bond Funds | Floating Rate Funds | Gilt Mutual Funds India | Find Top Liquid Funds In India | Long term debt funds | Low Duration Funds Debt Funds | Medium Duration Debt Funds | Medium To Long Duration Funds | Money Market Debt Funds | Overnight Debt Funds | Short Duration Debt Funds | Ultra Short Term Debt Fund
Hybrid: Aggressive Hybrid Funds | Arbitrage Mutual Funds | Balanced Advantage Mutual Funds | Conservative Hybrid Funds | Dynamic Asset Allocation | Equity Saving Funds | Multi Asset Funds | Multi Asset Allocation

Scroll to Top
Login to your account