Star Rating Or Ranking? What Is Better?

When it comes to investing in mutual funds, a bad choice that many investors make is to simply park their funds looking at the star ratings provided by many rating agencies. Ideally, you should use rating as a screening tool. In this article we have discussed the different basis on which the funds are rated and ranked and why picking the best methodology is crucial for long-term returns

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In India, if you look at the sheer number of mutual fund schemes that are available for investors, the figure can be quite intimidating. There are more than 1,000 open-ended mutual fund schemes to select from. And it becomes really difficult for investors to individually review each and every fund before taking an investment decision. So then how should investors go about selecting a fund? Most rely on star ratings, which are recommended by rating agencies. They are quite different from credit rating agencies. Hence, it is important not to confuse the two. In this article, whenever we say rating agencies, we clearly mean rating agencies that rate mutual fund schemes.

There are different rating agencies that have their own methods of rating or ranking mutual funds. Value Research, Morning Star, CRISIL, Rank MF, ICRA are a few of the organizations that rate MF schemes. There are several others too. Hence, do understand how they rate funds before blindly believing and investing. Needless to say, you should not invest in mutual funds just looking at the star ratings. You should actually use it as a screening tool. In the following paragraphs, we have discussed the different bases on which the funds are rated and ranked. Further, we would also try to find out for screening purposes which method is more robust and whether the rating or ranking is better.

Different agencies rate mutual funds differently with their proprietary developed methodology. Though it is quite difficult to understand how efficient they are, yet they can be used as your first screen. In this section, we would look at the star rating methodology of one of the most prominent rating agencies in the business.

First Screen