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The job of any ranking system is to make the investor’s life simpler and towards that end, we have drastically cut down the number of schemes in our list from 50 to 20. The list is the outcome of a two-stage process. In the first stage, Mint’s data partner Crisil applies a series of filters based on returns, risk and portfolio characteristics such as concentration, asset quality and liquidity. In the second stage, we spoke to fund managers to understand the fund’s strategy and screen out funds that have defects that a pure numbers-based approach may not detect. This year, we have taken some strategic decisions to simplify the list and make it more useful to ordinary investors. The four strategic decisions:

1) Swiss Army Knife funds

The overarching philosophy behind this year’s revision is that of a ‘Swiss Army Knife’. The idea to simplify and declutter the job of an investor. This means keeping the number of fund categories to a minimum and pointing readers towards categories that have the most flexibility to invest in a range of stocks and bonds. This is why we have replaced all existing categories in the hybrid fund space with a single ‘go anywhere’ sub-category which is balanced advantage funds. It should not be the job of an investor to determine whether equity allocation of 10-25% is better or 65-80%. This asset allocation decision is best placed in the hands of a fund manager without complex rules tying up his or her hands. Switching within a fund instead of between funds also saves a large amount of tax and this can make a big difference to returns, as we show here (bit.ly/3nF0kGm).

2) Passive in large-cap

A second trend that we have taken note of is that of a large number of actively managed mutual funds falling behind their passive counterparts, as evidenced in the reports of S&P Dow Jones Indices and others. Taking cognizance of this body of research, we have only picked passively managed index funds in the large-cap category.

3) Liquid is out

A series of regulatory steps taken to reduce the risk in liquid funds have largely pulled the ‘juice’ out of this category or its ability to do better than a simple bank savings account. Liquid funds have an exit load if redeemed within 7 days and a 20% cash holding norm (compared to 10% for other debt funds). The stamp duty on mutual fund transactions also makes very small holding periods unviable. We believe that horizons of up to 90 days are better fulfilled by bank savings accounts. For horizons of 90 days to 1 year, money market funds do a better job than liquid funds.

4) Out-of-the-box funds

Some funds are unique in terms of structure and cannot easily be compared to a peer set and judged against the latter. Such funds often drop out of mutual fund rankings that are overly wedded to a mechanical comparison system. Two such products that are out of the box and yet powerful enough to be in boxes of their own are the Bharat Bond Series of mutual funds and the Motilal Oswal S&P 500 Index Fund. Bharat Bond pioneered the concept of target maturity investing through a low-risk passive route. Motilal Oswal S&P 500 pioneered exposure to the world’s largest market through a passive index-oriented route. Both funds have seen competitors launched in recent years and as their respective categories mature, we will consider placing them through the traditional filters that pick schemes in standard categories like flexicap or large-cap.

What about the old list?

The current list is a lot smaller. This does not mean you should redeem your investments. Redemption tends to attract tax and exit load. Monitor your existing funds and redeem only if they underperform on a sustained basis.

Methodology:

We used rolling returns to evaluate the return performance given its superiority over trailing returns in its ability to capture the actual return experience, which is not marred by the level of net asset value (NAV) at the start or end date. For example, we used the three-year rolling active returns with respect to category benchmark, rolled daily for the last five years, for equity funds. For index funds, the primary criterion was tracking error for the last 3 years with respect to their stated benchmarks. For balanced advantage funds and debt funds, rolling 1-year return, rolled daily, for last 3 years was considered.

Alongside return, risk was also given weightage in all categories of mutual funds to varying degrees depending on the category in question. For instance, returns had a 50% weightage for equity funds, risk had a 25% weightage and portfolio characteristics (such as stock and sector concentration and liquidity) had a 25% weightage. For debt funds, returns had a 50% weightage and portfolio characteristics got a 40% weightage. The characteristics considered were also different such as issuer concentration, asset quality, modified duration and exposure to sensitive sectors. Risk was given a 10% weightage. Risk was measured using standard deviation of the rolling return. The period of analysis was broken into four overlapping periods and each period was assigned a progressive weight starting from the longest period as follows: 32.5%, 27.5%, 22.5% and 17.5%, respectively. In balanced advantage funds (BAFs), we gave a 50% weightage to returns, 25% to risk and 25% to downside risk. Downside risk is measured as the standard deviation of the scheme’s returns that are less than the benchmark returns In arbitrage, schemes with at least a 1 year history were considered eligible for the ranking. Thereafter schemes were selected based on mean return (60% weight), volatility (25% weight) and count of negative returns (15% weight). Mean return is the average of daily returns based on the scheme’s NAV for the period under analysis and volatility is the standard deviation of these returns.

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