Hello Readers! 

Investors while analyzing a fund to invest, use parameters like NAV performance and the star rating of the funds to pick out the best one for their goals. But here the contrary thing is, does the top-performing mutual fund or a fund with a five-star rating, remain the market leader ever?

Many agencies assign ratings to different mutual fund schemes and prepare a list of top-performing funds, only to ease the choice-making process to investors, but it does not guarantee that today’s top performer will be the leader tomorrow also.

How Are Ratings Assigned And Work? 

The performance of funds belonging to each category is analyzed against their peers using a quantitative measure (risk-adjusted returns) and as per their performance, they are star ratings. Like the top 10% of funds are awarded five stars, the next 22.5% receive four stars, and so on.

Now that you know how funds are assigned ratings if you have also invested in top-notch funds based on such rating methodology, can you expect it to perform poorly in the future?   

Before we conclude, let us look at the following aspects and understand them:

PAST IS HISTORY                         

The ratings are given to funds based on their past performance and these ratings do not guarantee the future performance of the fund. In fact, a study over different fund schemes shows that over the period 2004-2014, only 14% of five-star funds continued with their highest ratings. About 51% of five-star rated funds in 2004 received a four-star or above rating in 2014.

This survey clearly denies the theory that top fund performers remain on top ever. However, if you are staying invested for the long-term without chasing the highest return givers, then you stand a better chance of owning an outperformer.

HOW LONG HAVE YOU BEEN INVESTED?

The growth of your investment not only depends on the market position but rather it is much affected by your investing behavior also. The two basic behavior that leads to lesser returns from their investment is timing the market and constantly jumping out of underperformers and entering in to-performers. In this process, they don’t even realize that they might have perhaps lost out on much of the gains.

Fund schemes are volatile and go with the market trends, thus its performance is unpredictable. It will out-perform, sometimes under-performs based on its portfolio orientation and market trends. So basically, it is much important for you to decide how much you can hold the volatility in your funds and how long you can stay invested.

WHAT RATINGS DO YOU FOLLOW? 

Many agencies assign ratings to fund schemes and their parameters used are somewhat different from each other. Some take long-term performance as a basis, while others have a recency bias.

However, for an investor, it is always advised to evaluate the consistency of a fund’s performance in a longer horizon of 7-10 years.

IS THERE AN INVESTMENT PROCESS? 

Investors are humans that have habits to react over short-term things. They exit their funds in haste once they start underperforming, they even do not wait to see how the fund manager handles this volatility. There are two types of investment processes – one which is the normal regulatory process while the second has to do with the managerial approach including measures to protect portfolio and choose stocks or bonds.

So, before exiting your underperforming fund, you must enquire about the experience of the fund manager.

Last but not the least, exiting a fund as soon as it starts underperforming is never a wise decision. Stay invested for a time period of at least five years if investing in equities and exit funds only when they consistently underperform.

It good to look over the ratings of the fund while picking up one to invest in, but you must be prepared as the top-rated funds can also underperform in some instances

For any kind of query, you can contact us at Shri Ashutosh Securities Pvt Ltd., we are here to help you in any way possible.

Happy Investing!

(Mutual Fund investments are subject to market risk Illustrations are for example only, there is no guarantee of returns. Past performance is not an indicator/guarantee of future returns).