The Reserve Bank of India’s (RBI) monetary policy review was the much-awaited event for debt markets this month. Investors remained cautious and the government bond yields were more or less muted in the first half of the month on concerns over the expected move by central bank to curb inflation. However, the bond yields rose by the end of the month, after the central bank raised cash reserve ratio by higher-than-expected and held other key rates steady. The 10-year government bond yield ended higher by 5 basis points to 7.73% at the end of the month.
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At the monetary policy review, the central bank revised its growth projections to 7.5% from 6% supported by better-thanexpected industrial production and steady improvement in the private consumption. However, inflation still remains a cause of concern. After declining for three consecutive weeks, food price inflation rose to 17.56% for the week ended 23 January compared with 17.4% in the previous week. High food prices have driven up the Wholesale Price Index-based inflation to 7.31% in December from 4.78% in November. RBI revised its inflationary projections from 6.5% mentioned in its previous monetary policy to 8.5% for March.
In order to merit funds’ long-term performance, they have been ranked based on their one-year Morningstar risk-adjusted return for this review.
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 equals 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