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

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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.

prime ratings

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Please note that any specific queries on any of our recommendations will be answered ONLY through email. If you are a subscriber, please mail contact@primeinvestor.in.  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.

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

  1. Hi Bhavana – Excellent methodology of analyzing and rating the Mutual Funds. Very straightforward and easy to use tools. I build my own portfolio and for my family as well, so I research a lot on various portals – Advisor Khoj, Rupeevest, Morning Star, Fundoo, to finalize the schemes for investments. All these portals offer different metrics and hence becomes a tedious task to put all together from various portals. But its still worth it, as it offers me a 360 degree of the scheme.
    One of the things that is missing on all portals (including yours), is the impact on performance (short term or long term) basis the change of a Fund Manager. While the Fund’s philosophy and processes play a major role in driving performance, but ultimately the fund is managed and driven by a Fund Manager (a human), and one cannot dilute the impact she/he makes on the performance of the scheme. I have just signed up for the 14 trial to explore the way the ratings are provided and comparing with my data.

    As a seasoned investor, one would like to see information that is geared for that type of investor. For eg, the rating mechanism works well for novice and early investors who may not have the necessary knowledge or inclination to conduct their own research, and hence depend on ratings and recommendations to make their investment decisions.

    However for slightly seasoned/expert investors, just looking at the “rating” does not help. These set of investors would like to look at other data points, metrics which help them to make better decisions. Things like impact of Fund Manager, Expense Ratios, Rolling Returns of 1-3-5-7 years, performance during volatile periods, etc, would be of more interest to such class of investors. And your team can then package up these data points with your recommendations/outlook. (not offering Advisory as you are not a RIA).

    You and the team may want to think about offering a differentiated pricing plan for such seasoned investors to cater to their way of thinking and expectations.

    Good luck to your team, good work so far..!

    Rupesh Bhambwani

    1. Bhavana Acharya

      Thank you!

      Just addressing some of the points:

      1. We have a review tool separately where we give buy/sell/hold calls on funds. We don’t want our customers to use the ratings alone, because it hides a lot of qualitative aspects about a fund.
      2. Fund manager impact is hard to immediately quantify. It can either good or bad, and it’s more of a subjective call at the outset at least. Impact will show up in returns so to that extent the ratings will take care of it. But yes, it can be delayed. We take note of such changes in the review calls if we see impact.
      3. We’re working on providing more analysis tools in MF. Rolling return is one of them. Can’t give a definitive timeline for it, and it will take a good while yet but it’s in the works 🙂

      Thanks,
      Bhavana

  2. 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. Bhavana Acharya

      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

  3. 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

  4. Hi, There are “N” number of sites who are offering ratings as per their methodology.
    Why don’t you do something different from others.
    Like, if one scheme was performing better for 10 years since inception. But after 10 years the scheme under performed in its peers. Also down from 5 star to 2 star for say 2-3 years. But now again the cycle is turn around & that scheme improve its performance or star ratings, say rating revise to 3 star.
    This is the time where investors has to step in for better future returns. And that’s exactly you & your team members should do analysis. One has to enter into the scheme at the time of bottoming out. Not at top out.
    Many of investors enters at topping out, while the performance of the scheme or market at peak. And they lose at correction time or in distribution phase. This creates the bad sentiments about the Fund or market in investors mind. And he switched to Fixed Income or Debt products. If you & team guide investor at bottoming out, he will enjoy the fruits from 3 star to 5 star & more period in the same scheme. Or you can suggest investors to increase SIP while the scheme is nearing bottoming out.
    (Last year I invested in a new NFO of Healthcare Sector. And I got some opportunity to invest lump some even lower than the listed NAV. Today Pharma sector is seen revival. Even if I consider 3-5% down side from here then to its an opportunity for me to invest at deep. The NFO was launched at 8000 mark Nifty Pharma & I got an opportunity to add in at 7500 mark. What if I had invested at 12000 or 11000. I would have lose my interest. Nifty Pharma Index top out at 14020. I started at 8000-7500) This is what Investors expects from you & team.
    Also I would like to request you to add “Market Capture Ratio” for 3/5/7/10 years of the scheme.
    So the Investors will have hands on info of volatility or the performance of the scheme in both up & down side of the market.
    Hardly 1 or 2 sites are there who covers “Market Capture Ratio” that to for 3 & 5 years.
    I wish you & team all the best for the new venture.
    Thank you.

    1. Hello,

      Fund ratings are a useful metric to know at a quick glance which the better funds are. When we analyse funds, we inherently do a rating system to shortlist the outperformers. We’re putting this in a structured format with our MF ratings.

      There is also a need to distinguish a true sustained turnaround or drop in fund performance from a short-term movement that is momentary or short-lived. Our methodology strikes a balance between short-term and long-term performance and uses multiple metrics to address this. However, ratings are still based on pure past performance and cannot be predictive. Fund rating alone is not and should not be the only criteria to select funds.

      As you have mentioned, other factors are important – a poor fund picking up in performance, strategic calls on themes, and so on. But this needs a thorough understanding of fund investment style, strategy, and market scenarios – it is qualitative, not quantitative. In our fund recommendations, we go beyond just ratings to pick funds – we look at strategy, markets, portfolios, risks, slice and dice returns over the years and much more. Fund recommendations and portfolios which incorporate all this will be part of the subscription package that we’ll be launching soon.

      Thanks,
      Bhavana

  5. How consistent are the set of schemes in different categories in last 3 years basis PrimeInvestor rating methodology (Or what is the churn rate)? What percentage of universe is covered by you after filtering out schemes? How is the performance of the schemes in 1-2 years post getting 5 star rating?

    1. Hi Rahul,

      The ratings methodology combines long-term and short-term performance, and looks at factors that are more stable. Therefore, funds don’t quickly rise or fall sharply in ratings. The higher rated funds tend to remain above average. As mentioned in the post, we don’t rate sector/thematic, international, closed-end funds, and those categories where number of funds are too few to rate. We rate everything else.

      Thanks,
      Bhavana

  6. 1. You are zero when you start. And you need 1 to grow in AUM and age. Why prefer larger ones? Small is beautiful. Mirae Asset, Canara Robeco and others have shown this. If you need data, age may be the only criterion not AUM.
    2. By adding a half star, you are not being different. But adding to the confusion of layman investors. Of course, once you start your paid services, it is no longer for the layman. Anyway, my humble suggestion is you go for a completely different visual for rating systems. Consider adopting colors. Like bright green for 5*, light green for 4.5*, Navy blue for 4*, sky blue for 3.5*, yellow for 3*, light orange for 2.5*, dark orange for 2*, maroon for 1.5*, red for 1*.
    3. Many funds lower the expense ratio to attract investors. Once the AUM swells, they increase their exp.ratio. Flag such funds, if possible.
    Regards,

    1. Hi Vivek,

      Thanks for the suggestion on visual representation of ratings! Colour-coding may certainly be easy to grasp. To clarify on other points you’ve raised – one, our service is primarily for the layman investor. They are the ones most affected by the plethora of unstructured info out there, who need it the most, and where we can make a real difference. It’s less for extremely informed investors or those HNIs that can afford high-cost services. Our subscription fee will not be high and will not put it out of reach for people. Our service is not ratings alone. We will include fund and portfolio recommendations with regular follow-ups, plus recommendations on other personal finance products. We’re putting all this together in a format that will be easy for people to understand, so as to make it clear and avoid confusion.

      Yes, small funds can be good and become bigger over time. We keep an AUM cutoff for ratings since small funds can rank high but be much riskier than bigger and more stable funds, even in equity. It would be hard for everyone to understand the nuances of very small funds. It’s not that we’d completely ignore such funds – outside of ratings, we will be analysing and strategically recommending funds from time, and such funds could come in there. We change AUM cut-offs depending on the type of fund, as explained in the post.

      Half-star ratings, in our view, do offer greater differentiation between fund performances as explained in the methodology. We don’t think it will cause confusion. Expense ratio is a rating criteria in several fund categories, and a criteria we look at when making fund recommendations.

      Regards,
      Bhavana

  7. Not sure how much past data can be relied upon considering the sebi reclassification done last year.
    Some funds especially in mid-smallcap space have undergone substantial changes recently and also at AMC level.

    1. Hi Murali,

      True, SEBI’s reclassification has complicated things 🙂 But we’ve taken into account what funds used to be before reclassification and made adjustments for those by taking previously applicable benchmarks for certain performance data and weighting risks where needed. Where funds have completely changed, we’ve either refrained from rating them or compared them with relevant funds instead of their current stated category. The fact that we combine different categories during rating also helps address the reclassification problem. Hope this answers your doubts.

      Thanks,
      Bhavana

  8. Would be good to continuously evaluate the ratings. No other rating company does that. An investor needs to trust the ratings – often there is no accountability by the raters.

    1. Hi Amit,

      We’ll be updating the ratings every quarter. We also constantly evaluate behaviour of funds, and fine-tune our methodology to properly capture the changing nature of fund performance.

      Thanks,
      Bhavana

  9. Rather than sticking with conventional Star ratings, could there be a better visual representation to compare funds
    , For example, risk versus return as a window?

    1. Hi,

      Thanks for the suggestions. The idea behind using star ratings is that it is easy for anybody to understand and is clear. We definitely could explore visually representing characteristics of a fund later down the line.

      Regards,
      Bhavana

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