Dangers of relying on mutual fund star ratings and past performance

Last Updated on

Readers may be well aware that I am no fan of mutual fund star ratings. Star ratings and past performance if not understood with the right perspective can result in mistakes. In this post, let me give you an example – of my laziness that lead to a mistake in the July 2018 Equity Mutual Fund Performance Screener which is of course entirely based on past performance. The screener which I was publishing monthly was stopped in Jan 2018 as I waited for funds to get recategorized as per SEBI guidelines. So after a six-month break, my first task was to choose only those funds that have not changed “much” in nature.

Before we begin: This is the 3rd and final part of the PaisaVaisa Podcast where I talk about how to execute a financial freedom plan. Do give it a listen

I had about 414 funds in the Jan 2018 screener list. This was sorted according to Value Research fund categories. Now I had to remove funds that have changed significantly. Why? Suppose you have a fund that says it will try to point south most of the time. So you look at its history and find out how consistently it has done that. Then one fine day, it announces that it will try and point north. So all that past history of pointing south is now useless. Well, this is not what the screener is trying to do, but hopefully, you get the picture.

With the fund recategorization complete, I was looking for a way to restart the monthly screeners. On 26th June 2018, VR announced it new fund categories and also mentioned the following that instantly caught my eye:

A small number of funds which used to be rated earlier are no longer rated. There are two reasons for this:

  1. Some funds’ basic characteristics have changed. In these cases, the funds will be rated only when they have built up a long enough track-record in their new avatar. This is 18 months for debt funds and 3 years for equity and hybrid funds.

  2. We do not rate categories that are smaller than ten funds as the sample for comparison has to be a certain minimum size. Since, under the new system, there are a larger number of generally smaller categories, many funds which were formerly rated are now in small categories.

So the gears start turning in my head: Hey so all I need to do now is find out which funds have star ratings, get the new categories and then I can restart the past performance screener once again. I assumed that since VR still offers a rating for the fund, then it must not have changed in nature at least in the last three years. This is naturally an easy way out for me as I could not accomplish my task in an automated way. The alternative is pretty impossible – do a manual check. Like elsewhere in life, if we take the easy route, we have to pay the price. So what follows is an account of how I realised the mistake.

If you post every alternate day, you are soon to search for post ideas. So I got the July 2018 screener, decided to make a shortlist so that I can review the fund in detail. Then I demanded that funds benchmarked (by me) to our favourite index – NIfty Next 50 – should have outperformed it over every possible 1Y,2Y,3Y,4Y,5Y period at least 80% of the time. The funds should have also had a better downside protection over every possible 1Y,2Y,3Y,4Y,5Y period at least 80% of the time.

This gave me three funds:

  1. Principal Emerging Bluechip Fund-Direct Plan – Growth Option  (4-star at VR)
  2. Reliance Small Cap Fund-Direct Plan Growth Plan – Growth Option (4-start at VR)
  3. Mirae Asset Emerging Bluechip Fund-Direct Plan – Growth (5-star at VR)

DSP MIcrocap was a close fourth but is not listed because of its recent poor performance (1Y).

Among, these probably Mirae Emerging should be the most recognisable among DIY investors and is currently closed for subscription, other than via SIP. Now, the question is, have these fund changed in character or not? If they have, then the past performance is of no relevance. Therefore, the star rating (which is only based on past performance) is also useless.

Principal Emerging Bluechip Fund

From a fund that could invest between 65-95% in midcaps can now invest bet 35-65% in midcaps. There are many more changes, but that fact alone is enough to recognise that both the past performance and star rating is of no use! It was a mistake to have included this fund (with the best past performance!!) in the screener file. I could the easy route of trusting VR and paid the price for it  – embarrassment.

Reliance Small Cap Fund

As a saving grace, this fund has not changed much in nature. Earlier it merely called itself an open-ended equity scheme but did have small-cap focus and more importantly a small-cap benchmark. It is now an explicit small-cap fund with 65-100% exposure in small-caps. This is reasonable, and the use of the past performance is justified.

Mirae Asset Emerging Bluechip

This fund has changed from one that would invest 65-100% in midcaps to one that will now invest 35-65% in midcaps. Again that alone is enough to ignore past performance and star ratings. The full list of changes is here

I started with a pretty small short-list and two out of those three have to be rejected. sigh! Lesson learnt. Do not make the same mistake I did with your investments! Dig deeper, learn about how the fund will invest. Has it changed recently? If yes, then the past performance does not matter much. In any case, there is that disclaimer! So what is the way forward for the monthly screener? I will have to remove more funds like the above.The gears will have to start working again.

Hey dont forget: This is the 3rd and final part of the PaisaVaisa Podcast where I talk about how to execute a financial freedom plan. Do give it a listen

Do share if you found this useful

About the Author M Pattabiraman author of freefincal.comM. Pattabiraman(PhD) is the author and owner of freefincal.com.  He is an associate professor at the Indian Institute of Technology, Madras since Aug 2006. Pattu” as he is popularly known, has co-authored two print-books, You can be rich too with goal based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management.  He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice. Pattu publishes unbiased, promotion-free research, analysis and holistic money management advice. Freefincal serves more than one million readers a year (2.5 million page views) with numbers based analysis on topical issues and has more than a 100 free calculators on different aspects of insurance and investment analysis. He conducts free money management sessions for corporates  and associations(see details below). Previous engagements include World Bank, RBI, BHEL, Asian Paints, TamilNadu Investors Association etc. Contact information: freefincal {at} Gmail {dot} com (sponsored posts or paid collaborations will not be entertained)
Want to conduct a sales-free "basics of money management" session in your office?
I conduct free seminars to employees or societies. Only the very basics and getting-started steps are discussed (no scary math):For example: How to define financial goals, how to save tax with a clear goal in mind; How to use a credit card for maximum benefit; When to buy a house; How to start investing; where to invest; how to invest for and after retirement etc. depending on the audience. If you are interested, you can contact me: freefincal [at] Gmail [dot] com. I can do the talk via conferencing software, so there is no cost for your company. If you want me to travel, you need to cover my airfare (I live in Chennai)

Connect with us on social media

Content Policy

Freefincal has original unbiased, conflict-of-interest-free,  topical reports, reviews, commentary and analysis on all aspects of personal finance like mutual funds, stocks, insurance etc. All guest authors and contributors to the site also do not have any conflict of interest. If you find the content useful, please consider supporting us by (1) sharing our articles and (2) disabling ad-blockers for our site if you are using one. No promotional content We do not accept sponsored posts and link exchange requests from content writers and agencies. This is our privacy policy Our website is non-profit in nature. The revenue from the advertisement will only be used for hosting charges, domain registration charges, specific plugins necessary for traffic growth and analytics services for search engine optimisation.

Do check out my books

You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingMy first book is meant to help you ask the right questions, seek the right answers and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now.  It is also available in Kindle format.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You WantGamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantMy second book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at low cost! Get it or gift it to a young earner

The ultimate guide to travel by Pranav Surya

Travel-Training-Kit-Cover This is a deep dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, how travelling slowly is better financially and psychologically with links to the web pages and hand-holding at every step.  Get the pdf for ₹199 (instant download)

Free Apps for your Android Phone

All calculators from our book, “You can be Rich Too” are now available on Google Play!
Install Financial Freedom App! (Google Play Store)
Install Freefincal Retirement Planner App! (Google Play Store)
Find out if you have enough to say "FU" to your employer (Google Play Store)

Blog Comment Policy

Your thoughts are vital to the health of this blog and are the driving force behind the analysis and calculators that you see here. We welcome criticism and differing opinions. I will do my very best to respond to all comments asap. Please do not include hyperlinks or email ids in the comment body. Such comments will be moderated and I reserve the right to delete the entire comment or remove the links before approving them.


  1. I would like to share the story of two investors, who did investment in mutual fund as Lumpsum. Let be name as A & B.

    A & B decided to invest 3lacs in mutual fund in the month of June’15, regardless target, time, goal,etc., They both approached the same financial advisor , who is not fee- only category.
    Advisor recommended both to invest in the NFO which has launched that time.
    So, A – decided to put his entire amount in NFO ( Reliance retirement fund – Income generation – Growth – per unit rate is Rs.10/- ).
    Whereas, B not followed the financial advisor advise and asked him to select 10 schemes and picked 6 funds ( based on past returns & checked the various sites star rating, etc., ) and to put 50 k on each ( 1. Axis long term equity fund -R-G, 2) Canara robeco emerging equities -R-G, 3)DSPBR small cap- R-G, 4) Franklin India Smaller companies fund -R-G , 5)UTI Transport & Logistic fund-R-G, 6 )UTI Equity -R-G.

    They forgot this investment for 3 years and in June 2018, both checked their current fund value.
    Person A got shocked, when he saw his fund value ( it didn’t gave even FD returns ) and person B is happy with his fund value ( he added all funds and calculated the average returns and it gave 12 -15 % returns).

    Now, tell me who is the wise person.

    In this point of view, I shared some of my regrets with fee only advisors.
    First of all , they will ask so many questions & details like goal, tenure,before providing their advise.
    Secondly, they won’t recommend more than 2 funds for this type of small amount.
    Thirdly, In case if we followed even their two funds recommendation, not performed after 2nd 3 years, who will absorb the losses, obviously the investor only.Instead of that, we can invest in more funds and average the risk.
    Fee only advisors have their own thumb rule ( like one should not have more than five funds only like our hand )
    While selecting more funds, may be sectors overlapping will be there.
    For instance, if we found banking sectors fund will give more returns in future and we selected any one fund which has banking stocks.
    My point is, not all banks stocks will give good returns. May be HDFC & ICICI bank fund performed better than SBI.
    Instead of selected only one fund which holds SBI, rather select two or three funds which holds all these three banks stocks. Might be got average more returns

    I know my statement is not that much technical and grammatical way, If you want – please modify in your way.

  2. @PattuSir – Congrats Sir, They say that success of an online product( like Facebook, Gmail etc) is measured by the volume of spam traffic. If there is more spam then it means product is a success wrt to its reach and adoption. And hence by that metric your posts on fee-only mode of financial planning seems to have spooked the fee-based/commission based fans who have now started to use your own platform to try and show the fee-only planning in bad light.

    @Raajesh Kannan – This is an anecdotal argument, with many (incorrect) assumptions. You are operating with a prejudice that fee-only planners will not understand your goals better and will suggest 1 fund with zero diversification. I am not sure if that is the right way to summarize the merits of fee-only planners.

Leave a Reply

Your email address will not be published. Required fields are marked *