Why Distributors Should Not Rely On MF Ranking Agencies

Go for a fund house with a good track record across market cycles, large size and with skin in the game.

In the fine print of the consultation paper on RIAs, SEBI has proposed to regulate mutual fund rankings to bring uniformity and transparency across ranking agencies.

Let us start with the initial statements of SEBI on regulating such agencies. “It is simply a statistical sorting of similar peer group mutual fund schemes based on their past performances, risk and return analysis, etc. and is not an opinion on the future performance of the scheme/portfolio.” While in a way it sounds obvious, investors need to understand that it is a statistical sorting and the top rated funds are not necessarily the best funds. Simply put, these funds have performed better than others only in terms of certain parameters.

Take the next observation from SEBI: “Since ranking of mutual fund schemes is an objective statistical analysis of various parameters like risk and return, liquidity, performance ratio, etc. for past years, it appears to be more of a research work that serves as the basis for investment decision by the investors.” SEBI clarified that ranking is just a documented method to find out the past performers and not the subjective opinion of the ranking agencies.

The analysis is historical but for you, it is about the fund performance in a future period. Let us draw an analogy from cricket. If you are selecting a team on the basis of past performance, you would select batsmen like Sachin Tendulkar or Virat Kohli for top ranking. However, the best performer in the next match or series of matches could be some other batsman. It could be a proven player like Shikhar Dhawan or it could be a surprise like Karun Nayar.

There is another element of subjectivity in the analysis. Even an objective parameter like returns can be looked at from various perspectives. Let us look at the basic aspect of returns, without complicating it with things like risk-adjusted returns and statistical ratios. Returns may be measured as (a) simple point to point, i.e., returns till date over last one year, two years, and so on, or it could be (b) rolling returns.

These computation methods may throw up different winners for the same historical period. The point is that these outcomes can be used for your decision-making but only as one of the criteria, not the sole criterion.

This brings us to the core of the issue: what should be your criteria for choosing funds? It should start with the ‘hygiene factors’, i.e., even before you come to performance, it should satisfy certain basic criteria set by you. It could be the reputation and size of the AMC/sponsor, the stake in the business (it indicates importance of the mutual fund business to the business group) or it could even be the service level experience of the past.

After hygiene factors comes the investment objective of your clients. It could be to take advantage of India’s growth story, to benefit from small cap winners, to benefit from interest rates coming down from long bond funds or just earn steady returns in a rising interest rate scenario.

You have to identify funds that have good track record across market cycles. This is similar to the concept of ‘horses for courses’. Taking the analogy of cricket once again, selectors choose batsman Cheteswar Pujara for test cricket but not for one day or T20 cricket, due to his specialised skillsets. Choose funds that have performed better in the past, but you need not necessarily go in the order of ranking given by the ranking agency.

To conclude, SEBI proposes that the “activity of ranking of MF schemes shall be brought under the regulatory ambit of SEBI (Research Analysts) Regulations, 2014” and “over time, it may be appropriate to relax strict limitations on advertising that prohibit the use of third party non-compensated fund rankings or other information that is not false or misleading”. As and when that happens, you can fall back upon it, but remember to use it in the manner discussed here.

Source : https://cafemutual.com/news/guestcolumn/307-why-distributors-should-not-rely-on-mf-ranking-agencies

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