Part II: Here is why you should ignore mutual fund star ratings

Published: October 6, 2014 at 9:02 am

Last Updated on September 4, 2018

In the first part on why you should ignore mutual fund star ratings, I had stressed on the importance of focusing on our portfolio health and performance of the fund with its benchmarks.

In this post I would like to add a couple more reasons to strengthen the argument.

Let us assume that an investor named Tom has chosen to ignore my thoughts on this matter and decided to invest as per fund star ratings.

Which star ratings should he choose?

Value Research, Morning Star, Money Control, thefundoo, or others?

Not all star ratings are created equal. Each one differs in methodology. Even if the difference are small, the results can vary by a wide margin.

Take the case of ICICI Prudential Top 100 Fund, an excellent large-cap fund (analysis in a forthcoming post) with a consistent track record since 1998. It is managed by one of the best portfolio managers in the country: Sankaren Naren

Value Research rating: 5*

Morning Star: 4*

thefundoo: 3*

Moneycontrol: 4* (Crisil rating 2 in large cap category)

ICRA Online Rankings: 3*

Which rating system should Tom choose and why?

To answer this, the follow options present itself to Tom:

  • Read the methodology of each system. Assuming that he understands each of them, choose one that he is ‘comfortable with’!
  • Use what everyone is using.  But how the hell will Tom know that in the first place?!
  • Pick one rating portal, write to them and find out which Tom should use?! Objective answers guaranteed!
  • Look at the website. If it looks impressive and easy to use, Tom can assume that the rankings are solid too!

As long as Tom wears horse blinders and sticks to one rating portal everything seems fine. The moment he compares ratings offered by different portals,  he realizes (hopefully) that the guidelines for calling a fund as 5* or 3* are purely arbitrary. The guidelines are consistent and based on solid math, no doubt, but they are arbitrary nonetheless.

I say this because the criterion used each rating agency can differ. One fund portals risk-free rate could be different from another. The duration chosen to grade funds can vary.  The way in which each metic is calculated can vary.

This is the primary reason why investors should avoid star ratings. Instead of these arbitrary guidelines, why not use some personalized, and therefore absolute ones likes our (reasonable) return expectation, net portfolio returns, position of the fund in the portfolio and  consistency of performance wrt benchmark?

I would like to recommend the following simple way to evaluate a fund wrt its benchmark to the Toms of this world.

 Sab star ratings chodo. Use the Mutual Fund Risk  Return analyzer instead!

It compares the funds performance with that of its index for 1,2,3….8 year durations with 19 risk and return metrics and offers a simple score out of 100% for each year.  A ‘good fund” is one which has consistently recorded a high score.

The user is free to set the risk-free rate and the minium acceptable return.  It is open source so you can add or remove metrics as you please (removing is easier than adding though!).

It is an absolute measure of outperformance (or the lack thereof) in the sense that only funds benchmark is compared with the fund. You have about 35 equity benchmarks to choose from.

Both the long-term and short-term performance is taken into account unlike most star ratings.

Here is how ICICI Top 100 fared


It is a terrific fund. It has beat its benchmark on an absolute and risk-adjusted basis consistently for the past 8 years. This is more important than the number of stars  someone gives a fund.

Of course, this information is relevant to the investor only if he/she understands how to build a minimalist portfolio (coming soon!): one in which each fund has a specific role.

Not all funds rated 5* by the same agency are created equal.


Would you invest in this fund, rated 5* by VRonline? It is also benchmarked to the Nifty.

Use the data provided by the fund ratings portals and not the ratings themselves.  Carpe Diem.

Do share if you found this useful

Did you know? We have more than 900+ videos on YouTube to explore! Join our YouTube Community!

Use our Robo-advisory Excel Template for a start-to-finish financial plan!

Join our courses in exclusive Facebook Groups!

  • 500+ members are now part of our new course, How to get people to pay for your skills! (watch 1st lecture for free). Learn how to get people to pay for your skills! Whether you are a professional or small business owner wanting more clients via online visibility or a salaried person wanting a side income or passive income, we will show how to achieve by showcasing your skills, building a community that trusts you and pays you!
  • 1822 members have signed for Goal-based portfolio management (watch 1st lecture for free). This is an online course to reduce fear, uncertainty and doubt while investing for a financial goal. Learn how to plan for your goals before and after retirement with confidence.

Want to check if the market is overvalued or undervalued? Use our market valuation tool (will work with any index!) or you buy the new Tactical Buy/Sell timing tool!
We publish mutual fund screeners and momentum, low volatility stock screeners on a monthly basis
About the Author Pattabiraman editor freefincalM. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman 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. He conducts free money management sessions for corporates and associations on the basis of money management. Previous engagements include World Bank, RBI, BHEL, Asian Paints, Cognizant, Madras Atomic Power Station, Honeywell, Tamil Nadu Investors Association, IIST Alumni Association. For speaking engagements write to pattu [at] freefincal [dot] com
About freefincal & its content policy Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on developments in mutual funds, stocks, investing, retirement and personal finance. We do so without conflict of interest and bias. Follow us on Google News Freefincal serves more than one million readers a year (2.5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified from credible and knowledgeable sources before publication. Freefincal does not publish any kind of paid articles, promotions or PR, satire or opinions without data. All opinions presented will only be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
Our publications

You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingPublished by CNBC TV18, this 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 Want Gamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantThis 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

Your Ultimate Guide to Travel

Travel-Training-Kit-Cover-new 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 Rs 199 (instant download)
Free android apps