Business Today

The Distillation

Print Edition: Apr 1, 2012

Business Today Fund Awards have been conceived to solve a specific problem that investors have. The problem is simple-there are too many funds of varied kind and investors don't know how to begin understanding this universe. They don't have a framework within which to map their investing needs to the bewildering variety of funds that exist. There's no clear way to know which funds should fit into this framework and which should be ignored.

For two decades now, Value Research has been working to bring order to this chaos. Over these years, we have evolved two different ways of classifying mutual funds. One is based on what investments funds invest in, and the other on what need they fulfill for the investor. An example of a category by the former system is 'Equity: Large & Mid-cap' while one from latter is 'Growth'. The former system is intended for experienced or professional investors and the latter for someone who just wants a solution to his needs without getting too deeply into the nitty-gritty.

To simply it further, we have kept all niche fund categories out of our framework. These include the sector and thematic funds which ordinary investors should anyway keep away from.

Here is a brief note on fund categories:

i. Aggressive Growth - Universe of multi-cap, mid and small cap funds.

Diversified equity funds with an average allocation of 40 to 60 per cent of their assets to large cap stocks, based on the half yearly full portfolios of the past three years have been classified as multi cap funds. While those with an average allocation of less than 40 per

cent to large cap stocks were classified as mid and small cap funds.

ii. Growth - Universe of large and large & mid-cap funds.

Diversified equity funds with an average allocation of 60 to 80 per cent of their assets to large cap stocks, based on the half yearly full portfolios of the past three years have been classified as large & mid cap funds. While those with an average allocation of more than 80 per cent to large cap stocks were classified as large cap funds.

iii. Conservative Growth - Universe of balanced funds.

This included the set of equity oriented hybrid funds. The funds with an average equity exposure of more than 60% based on the last three years' full portfolios were classified as balanced funds.

iv. Income - Universe of medium and long-term bond funds.

All the income and gilt funds as per their stated objectives were considered in this category. These funds have the leeway to move full into cash or go to any extremes of the maturity band, based on the interest rate outlook of the fund manager.

v. Cash - Universe of liquid and ultra short funds.

This peer set includes all the liquid funds (funds with upto 91 days of average maturity) and ultra short-term funds which keep a very low maturity but do not qualify the legal definition of liquid funds and hence have a lower dividend distribution tax applicable for non-liquid funds.

We applied our proprietary risk-adjusted rating model for the above investor centric fund classification to choose the best funds for your financial goals. The Rating is a composite measure of both returns and risk. This single measure combines the Value Research Fund Risk Grade and the Value Research Fund Return Grade to give an indication of a funds risk-adjusted return. This rating is purely quantitative and there is no subjective component to it. It is a unified performance measure and summarises how a fund has performed historically, relative to the other funds in its category, for the risks it has taken.

The fund ratings are based on trailing 3-year performance of each fund vis-à-vis other funds in each category. Any fund which is not 3-year old has not qualified for rating.  Also a fund with less than Rs 100 crores of average assets under management in the past six months has not been considered.

The Value Research Fund Rating is determined by subtracting the fund's Risk Score from its Return Score. The resulting number is then rated according to the following distribution.

*****      Top 10%

****        Next 22.5%

***        Middle 35%

**           Next 22.5%

*           Bottom 10%

The Value Research Fund Risk Grade captures the fund's risk of loss. It is different from the conventional risk and volatility measures like standard deviation and beta as it indicates only downside volatility. The latter refers to absolute losses and even periods when the fund underperforms a risk-free guaranteed investment. The rationale: you can always get a guaranteed return by investing in a risk-free guaranteed investment like a bank term-deposit. The risk of investing in a mutual fund not only includes the possibility of losing money, but also the chance of earning less than you would have on a guaranteed investment.

To calculate Fund Risk, monthly/weekly fund returns are compared against the monthly risk-free return for equity and hybrid funds and weekly risk-free return for debt funds. Risk-free return is defined as State Bank's 45-180 days Term Deposit Rate. For all months/weeks the fund has underperformed the risk-free return, the magnitude of underperformance is added. This helps us to arrive at the average underperformance and how the fund has performed vis-à-vis its category average. The relative performance of the fund is expressed as a risk score.

The Value Research Fund Return Grade captures a fund's risk-adjusted return in comparison to other funds in the category. The returns though adjusted for dividend, bonus or rights, are not adjusted for loads. The fund's monthly/weekly return is compared with the monthly/weekly risk-free return to arrive at the fund's total return in excess of the risk-free return. The monthly average risk-adjusted return is compared with the average category return to arrive at the overall score. The overall scores are then multiplied by 100 to make them more readable.

Other categories

Best Fund House

Best Equity Fund Manager

Best Debt Fund Manager

1. For the above exercise, the universe of mainstream funds were only considered. This meant exclusion of niche and peripheral categories and fund categories which are fairly commoditized by their very design.

The Universe

Equity: Large & Mid Cap

Equity: Large Cap

Equity: Mid & Small Cap

Equity: Multi Cap

Equity: Tax Planning

Equity: Infrastructure

Hybrid: Equity-oriented

Hybrid: Debt-oriented Conservative

Hybrid: Debt-oriented Aggressive

Hybrid: Arbitrage

Hybrid: Asset Allocation

Debt: Income

Debt: Short Term

Excluded Categories:

Debt: FMP

Debt: Gilt Medium & Long Term

Debt: Gilt Short Term

Debt: Liquid

Debt: Ultra Short Term

Equity: Banking

Equity: FMCG

Equity: International

Equity: Others

Equity: Pharma

Equity: Technology

Gold: Funds

Hybrid: Others

2. The exercise was based on the quarterly performance over the past 5-years (20 quarters). Each quarterly performance of a fund was assigned a quartile rank in their respective categories.

Best Fund House

The fund house with relatively highest top quartile performance was adjudged the best.

Fund companies with less than Rs 500 crore asset under management and companies which started in the past five-year were not considered.

Best Equity and Debt Fund Manager

The fund manager with relatively highest top quartile performance was adjudged the best fund manager. This was irrespective of his job change, i.e. if a fund manager moved from one fund to another, he was attributed the fund performance for his term across fund houses. Managers with less than Rs 100 crore under management were excluded.

Fund managers with minimum of 5-year track record were only considered.

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