Expectations of monetary tightening and higher inflationary pressures continued to weigh on investors’ sentiments in December. The bond yields moved up during the month as investors turned cautious after hawkish comments from the Reserve Bank of India. The inflation rate on primary articles continued to remain upbeat and spiralled. It increased to 15.5% for the week ended 19 December, up from 11.04% for the week ended 14 November. The Wholesale Price Index surged to 4.78% for November, up from 1.34% in previous month.
Higher inflation and stronger macroeconomic data is likely to result in the central bank resorting to end its soft interest rate regime. Worries of higher crude oil prices owing to heightened tensions in West Asia also made investors wary. On the positive side, the bond market took comfort from ample liquidity in the banking system.
The yield on the 10-year benchmark government bond increased to 7.66% in December, from 7.3% in the previous month. The rise in bond yields affected debt funds, particularly those focusing on longer tenure bonds and government securities. The Morningstar intermediate bond funds category registered a -0.16% return, while the intermediate and long government securities dedicated funds were down 0.2% and 0.3%, respectively.
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.
Click here to read more
Graphics by Yogesh Kumar / Mint