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Global concerns weigh on equity funds

Global concerns weigh on equity funds
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First Published: Thu, Feb 18 2010. 01 15 AM IST

Updated: Thu, Feb 18 2010. 01 40 PM IST
After having rallied for two consecutive months, the equity markets declined in the first month of the year. The markets started the month on a positive note, driven by better-than-expected Index of Industrial Production (IIP) growth and improved exports. However, it turned bearish by mid-month and ended lower due to disappointments from key corporate earnings and weak global cues. The country’s IIP surged faster than expected and grew by 11.7%, primarily due to strong demand for manufactured goods. The fear of monetary tightening by the central bank weighed on market sentiments.
The Bombay Stock Exchange’s (BSE) Sensex declined by 6.3%, while the Nifty on the National Stock Exchange fell by 6.1% in January. The small-cap shares continued to outperform their large- and mid-cap counterparts. Among sectoral indices, all indices ended in the red except consumer durables, which rose for the second consecutive month and was up 0.2%. Investors turned cautious on rate-sensitive stocks ahead of RBI’s monetary review. Foreign institutional investors after being net buyers for 10 months in a row turned net sellers in January because of the strengthening of the US dollar. They sold equities worth Rs500 crore.
In order to merit funds’ long-term performance, they have been ranked based on their one-year Morningstar risk-adjusted return for this review.
Also See Graphics
Methodology
The Morningstar star rating methodology is based on a fund’s risk-adjusted return denoted as Morningstar risk-adjusted return (MRAR) within a given Morningstar category. Morningstar categorizes funds based on their average holdings statistics for the past three years.
Morningstar uses expected utility theory as the basis for MRAR. The expected utility theory determines how much return an investor is willing to give up to reduce risk. Therefore, MRAR gives more importance to a fund’s downside deviation. To calculate MRAR, a fund’s monthly total return is calculated. The total return is then adjusted for risk-free rate to arrive at the Morningstar return. The Morningstar return is then adjusted for risk to calculate MRAR. Morningstar uses parameter gamma to describe investors’ sensitivity to risk.
Morningstar fund analysts have concluded that gamma equal to two results in fund rankings that are consistent with the risk tolerances of typical retail investors. Morningstar risk is calculated as the difference between Morningstar return and MRAR.
Morningstar rating is calculated every month for 3-, 5- and 10-year periods. The fund’s overall rating is calculated based on a weighted average of the available time period ratings. Within each rating period, the top 10% funds receive a five-star rating, the next 22.50% earn a four-star rating, the next 35% get three stars, the next 22.50% receive two stars, and the last 10% get one star.
Morningstar rates each share class of a fund separately, because each share class has different loads, fees and total return time periods available. The distribution of funds among the star ratings depend on the number of portfolios evaluated within the category, rather than the number of share classes available.
Graphics by Ahmed Raza Khan / Mint
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First Published: Thu, Feb 18 2010. 01 15 AM IST