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Are Star Rated Funds Performing like Stars? - Outside View by PersonalFN

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Are Star Rated Funds Performing like Stars?
Jul 1, 2015

In athletics, if a player performs badly on one day, that doesn't make him a bad athlete. Similarly, one who does remarkably well in just one game and disappears thereafter is not a good athlete either. In essence, abilities of athletes can't be and should not be judged on their recent performance.

On parallel lines, mutual funds which have generated extraordinary returns in last bull phase should not be construed to be the best funds. There are a number of criteria that funds have to pass on before they flaunt to be the best funds or funds which command high star rating.

Remember, 'star ratings' can often be misleading. Highest weight is assigned to the recent performance and often, only quantitative parameters are considered for rating funds. It has also been seen that funds enjoying high star ratings see greater inflow in Assets Under Management (AUM) as investors chase funds that have a good reputation. But then, do these funds really performed in accordance to the star rating conferred on them?

PersonalFN is of the view that investors should not blindly go by star ratings and try to delve deeper into understanding the methodology used for rating funds.

Through this article PersonalFN brings to you a thorough analysis of funds that have enjoyed a good rating along the ones which hold the potential to perform well.

Over last 3 years, the Indian equity market has clocked phenomenal returns. Midcaps have run ahead of largecaps indices, while the broader market has ascended. As on June 26, 2015, the S&P BSE Mid-Cap index is up 77% over a 3 year period, while the broader indices - S&P BSE Sensex and S&P BSE 500 are up nearly 65%  and 68% respectively.

Popular funds with large asset base...
Scheme Name AUM (Rs in Crore) Rise in AUM over last 3 years
HDFC Equity Fund (G) 18,165 82%
HDFC Top 200 Fund (G) 13,593 17%
Reliance Equity Opportunities Fund (G) 11,650 235%
HDFC Mid-Cap Opportunities Fund (G) 10,220 380%
ICICI Pru Value Discovery Fund (G) 9,631 427%
Birla SL Frontline Equity Fund(G) 9,208 232%
ICICI Pru Focused BlueChip Eq Fund (G) 9,089 137%
IDFC Premier Equity Fund (G) 7,229 156%
Franklin India Bluechip Fund (G) 6,479 33%
ICICI Pru Dynamic Plan (G) 5,970 49%
AUM is as per the portfolio disclosed on May 31, 2015
Rise in AUM is in 'absolute' terms and calculated for 3-Year period
(Source: ACE MF, PersonalFN Research)

As per table above, of top-10 funds by AUM nearly 7 have witnessed a stupendous growth in their asset base, which is much more than the rise in the broader market over the last 3 years. So, this suggests that 7 funds have witnessed enormous net inflows amid the times of exuberance.

Going by numbers, ICICI Prudential Discovery Fund and HDFC Mid-Cap Opportunities Fund were recipients of huge net inflows over last 3 years, while HDFC Top 200 Fund and Franklin India Bluechip Fund recorded an ordinary growth in AUM. This suggests, that even in case of most popular funds, there is a vast difference in perception of investors.

Purely on the statistical merit, HDFC Mutual Fund and ICICI Prudential Mutual Fund are the dominant players; but surprisingly there isn't a single scheme of some of the other large fund houses such as SBI Mutual Fund, and UTI Mutual Fund in the list of top-10 funds by AUM.

How have high star rated funds fared?

Scheme Name Returns in (%)
1 Year 2 Years 3 Years 5 Years
ICICI Pru Value Discovery Fund (G) 29.5 49.8 34.0 20.3
HDFC Mid-Cap Opportunities Fund (G) 30.3 47.8 33.3 21.3
IDFC Premier Equity Fund (G) 30.3 39.8 30.2 19.3
Reliance Equity Opportunities Fund (G) 22.6 35.8 26.6 17.6
Birla SL Frontline Equity Fund (G) 20.5 29.9 26.0 14.5
HDFC Equity Fund (G) 11.9 31.9 22.8 13.0
ICICI Pru Focused BlueChip Eq Fund (G) 16.8 27.3 22.4 14.6
ICICI Pru Dynamic Plan (G) 10.4 30.0 21.4 13.1
Franklin India Bluechip Fund(G) 21.3 25.3 20.4 12.6
HDFC Top 200 Fund (G) 9.8 26.8 20.2 11.7
Average Returns # 22.1 33.6 25.0 13.6
S&P BSE Sensex 10.8 19.8 17.9 9.4
S&P BSE 200 13.7 22.9 18.9 9.2
S&P BSE 500 13.2 23.5 18.7 9.0
S&P BSE Mid-Cap 16.1 34.0 20.9 8.3
Data as on June 26, 2015
Returns over 1 year period are compounded annualised, while for less than 1 year are expressed in 'absolute' terms
#Average returns constitute of 154 diversified equity funds with track record of minimum 3 years
(Source: ACE MF, PersonalFN Research)

The performance of popular funds highlights a few things...

Over a 3-year time frame, from the list of top-10 funds by AUM 5 funds have clocked slower returns which are below the average returns of diversified equity funds. While on 1-Year time period, 6 of 10 most popular funds in the diversified category underperformed the average returns and 4 such funds were spotted when assessed on a 5-year time frame.

Who topped the charts?
Scheme Name 1 Year 2 Years 3 Years 5 Years Growth in AUM
Franklin India Smaller Cos Fund (G) 37.3 53.5 42.0 22.8 612%
SBI Small&Midcap Fund (G) 55.8 57.9 41.7 22.9 1180%
SBI Magnum MidCap Fund (G) 43.8 54.9 41.0 21.8 376%
DSPBR Micro-Cap Fund (G) 48.5 63.6 38.9 21.0 356%
Mirae Asset Emerging BlueChip (G) 40.8 54.0 38.7 - 560%
Reliance Small Cap Fund (G) 26.3 61.8 37.9 - 278%
UTI Mid Cap Fund (D) 37.3 57.3 37.8 20.6 952%
JPMorgan India Mid and Small Cap Fund (G) 37.9 51.6 37.6 21.1 268%
Canara Rob Emerg Eq Fund (G) 38.3 58.7 37.1 22.6 1163%
Franklin India Prima Fund (G) 35.7 46.1 36.7 20.4 416%
S&P BSE Sensex 10.8 19.8 17.9 9.4 -
S&P BSE 200 13.7 22.9 18.9 9.2 -
S&P BSE 500 13.2 23.5 18.7 9.0 -
S&P BSE Mid-Cap 16.1 34.0 20.9 8.3 -
Data as on June 26, 2015
Returns over 1 year period are compounded annualised, while for less than 1 year are expressed in 'absolute' terms
(Source: ACE MF, PersonalFN Research)

Well, the show stoppers amid the exuberance in the Indian equity market were funds having a mandate to invest in the mid and small cap domain. Fund such as Franklin India Smaller Companies Fund, SBI Small&Midcap Fund, SBI Magnum MidCap Fund, DSPBR Micro-Cap Fund and Mirae Asset Emerging BlueChip clocked appealing returns as the midcap rallied ahead of large caps and caught the attention of many investors too.

Only a handful of funds from the list of top-10 funds based on AUM, viz. ICICI Prudential Value Discovery Fund, HDFC Mid-Cap Opportunities Fund and IDFC Premier Equity Fund - which either follow a value style of investing or predominantly invest in the mid and small cap space - have exhibited appealing performance in accordance to the star ratings they enjoy.

A prudent approach to follow while you invest...

PersonalFN believes, rather than focusing only on recent performance of the fund or following the star ratings, you should adopt a more comprehensive approach and consider host qualitative and quantitative factors. Qualitative factors include the following, amongst a host of others:

  • Assessing the Fund manager's experience
  • The number of schemes the fund manager manages
  • Proportion of AUM of the fund house which is actually performing
  • Is the fund house offering unique schemes or rolling out old wine in new bottles in the race to garner more AUM
  • Understand the organisational structure
  • Recognise the investment processes and systems
Amongst the quantitative factors you should consider:
  • Past performance on various time frames
  • Performance across market phases of bulls and bears
  • Risk-return trade off
  • Portfolio characteristic (wherein judge where your money is invested, portfolio concentration and number of times the fund manager is churning the portfolio)
  • Expense ratio charged by the fund
Hence before you put faith investing in star rated mutual funds please assess how they are rated on various parameters. Remember, sole dependence on only the quantitative parameters, for selecting mutual funds for your investment portfolio, is not the right thing to do; because these stars (based on quantitative parameters) may not always shine. It is your hard earned money and it is vital for you to take a prudent investment decision. Merely going by the star rated funds may not always provide sparkling returns to your portfolio. And do remember, when you invest in equity oriented mutual funds, have a time horizon of atleast 5 years.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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