Vishal wants to buy a new car. Before he spends his hard-earned money on his new pair of wheels, he needs to be sure about the best buy in the market. To do this, he asks his closest friends, looks at 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. Especially, if we are a first-time investor and have no real knowledge of the market. A friend who can help us on this journey is Value Research – a Delhi-based, independent, mutual fund research house. If mutual funds were cars, Value Research is akin to Autocar India. Every year, the company releases its ‘Fund Ratings’ which investors use as a benchmark to allocate assets.
1. What is Value Research Fund Rating?
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 establishing fund ratings. 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.
2. How are Funds rated?
To begin with, Value Research does not use this rating mechanism to rate equity or hybrid funds that have been on the market for less than 3 years. For debt funds, this time period is 18-months long. Basically, 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.
a. For Equity and Hybrid Funds
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.
b. For Debt Funds
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 own 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 crores (in the past six months preceding the rating process) from the rating process.
3. What is Value Research Fund Risk Grade?
The Value Research Fund Risk Grade is a quantitative assessment of a fund’s risk of loss. Fund Risk Grade differs significantly from the 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 absolute losses and even time 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.
4. How is fund risk calculated?
To calculate Fund Risk and grade funds accordingly, the given fund’s returns are compared against the expected monthly risk-free return (for equity and hybrid funds) and weekly risk-free return (for debt funds). Now, the magnitude of underperformance for the duration of underperformance (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.
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.
5. What is Value Research Fund Return Grade?
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 adjusted 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 weekly risk-free return (for debt funds). This helps the analysts arrive at the fund’s total return in excess of 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 in excess of one means that the particular fund has performed better than its category average, and vice-versa.
6. How is the Value Research rating useful?
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 in them through ClearTax’s online portal. Happy savings!