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Vishal wants to buy a new car. For this, he needs to be sure about the best buy in the market. To do this, he asks his closest friends, checks reviews online, and then finally makes his decision. Needless to say, his well-informed decision will last him a long time! When it comes to buying mutual funds, all of us need to be like Vishal. If you are a first-time investor and have no real knowledge of the market, then you need to research the best option available.
A friend who can help us on this journey is Value Research – an independent mutual fund research house. Every year, the company releases its ‘Fund Ratings’ which investors use as a benchmark to allocate assets.
In this article, we have provided detailed information as to what these ratings mean, how they are established, and how they help investors make wise decisions.
Value Research Fund Rating (aka Risk-adjusted Rating) is a metric that can be defined as a composite measure of both the returns and risk associated with a particular fund. The rating is purely quantitative, and Value Research has clarified that there is no subjective component to their process of rating a fund. Thus, we can safely assume that the fund rating is not reflective of the company’s opinion of a fund and its future potential. The rating only gives investors a quick summary and a perspective on a fund’s performance, when compared to that of its peers.
To begin with, Value Research does not use this rating mechanism for equity or hybrid funds that have been in the market for less than three years. For debt funds, this period is 18-months long. The company does not rate or review funds that do not have an established track record as it becomes impossible to do a comparison between the fund’s historical performance and that of its peers.
Value Research ratings for this fund type combine ratings for two time period (3 and 5 years) and provide investors with a single assessment of each fund’s risk rating vis-à-vis others in its category.
This fund type is rated on 18-month weekly risk-adjusted performance, and the ratings are relative to the other funds in the same category. The rating mechanism has its criteria for funds to qualify for this rating: i. Each category must have a minimum of 10 funds for it to be rated ii.Effective, July 2008, the company has added additional qualifying criteria whereby it excludes funds with an average AUM of less than Rs.5 crore (in the past six months preceding the rating process) from the rating process.
The Value Research Fund Risk Grade is a quantitative assessment of a fund’s risk of loss. Fund Risk Grade differs significantly from conventional risk and volatility measures like standard deviation and beta. This is because it only indicates negative volatility. This means that the grade refers to total losses and even periods when a fund underperforms on a risk-free guaranteed investment.
The rationale behind this is that an investor can always get a guaranteed return by investing in risk-free guaranteed investments like a bank deposit. The risk of investing in a mutual fund, therefore, should not only include the possibility of losing money but also reflect the investor’s chances of earning less than what they would have on a guaranteed investment.
The given fund’s returns are compared against the expected monthly risk-free return (for equity and hybrid funds) and risk-free weekly return (for debt funds) to calculate fund risk and grade funds. Now, the magnitude of underperformance for the duration (weeks/months) is summed up. This helps the company to arrive at the fund’s average underperformance score and understand how badly the fund has performed vis-à-vis its category average. This relative performance is then expressed as a risk score.
Note: Risk-free return, in this case, is defined according to the State Bank of India’s 45-180 days Term Deposit Rate.
The top 10% of the funds are rated as ‘High Risk’, next 22.5% are rated as ‘Above Average Risk’, the middle 35% are rated as ‘Average Risk’, while the next 22.5% are rated as ‘Below Average Risk’. The funds in the bottom 10% risk score are rated as ‘Low Risk’ funds.
The Value Research Fund Return Grade is a numerical score that captures a fund’s risk-adjusted return as compared to other funds in the category. These returns though adjusted for dividend, bonus, and rights, are not fit for loads when doing the calculations. As before, the given fund’s returns are compared against the expected monthly risk-free return (for equity and hybrid funds) and risk-free weekly return (for debt funds).
This helps the analysts arrive at the fund’s total return over the risk-free return. The final score is calculated by comparing the monthly average risk-adjusted return with the category average. In case of a negative category average return (as in when the entire fund category has given low returns due to market fluctuations), the risk-free return is used as a benchmark. Any fund with a score over one means that the particular fund has performed better than its category average, and vice-versa.
Now that you understand Value Research ratings, you can use them to find the mutual fund that best suits your needs. Remember the ideal mutual fund is one with a low-risk score but a high return grade. When you find the best fund for your investments, make sure to invest in them through ClearTax’s online portal. Happy savings!