Why is ICICI Pru Nifty Next 50 Index Fund rated one-star?

Last Updated on August 22, 2022 at 11:11 pm

Ramesh asks, “Dear Pattu Sir, I have invested in ICICI Prudential Nifty Next 50 Index Fund Direct Plan via SIP since 2019. I recently read your post in Asan Ideas for Wealth (a Facebook group) that Value Research (VR) has rated this fund one-star. Can you please explain why this is so? Should I continue investing in this fund or choose another Nifty Next 50 fund. Please advise.”

To answer this question, we must understand how the star ratings are decided. We have already explained this in simple words: What are mutual fund star ratings (in plain English)? So we shall directly proceed with an example.  Consider two mutual funds, X and Y. Fund X is benchmarked to an index B1  and fund Y to B2.

To evaluate fund performance, the natural, logical thing to do would be to ask, “how did X perform in terms of risk and reward wrt index B1 and Y wrt index B2?”. Of course, the question, “how did fund X perform wrt fund Y?” is also a natural question to ask (even if not always logical!).

Mutual fund star ratings are not interested in the first question! They only try and answer the second question – “how did X perform wrt Y?”. So the primary factor in determining the star rating of a fund is the grouping.

Fund X and fund Y should be similar in style and from the same stock universe (in equity funds) to be put together in the same category. Before the SEBI MF categorisation rules, VR used their own grouping scheme. Now they stay close to the SEBI MF rules.

Also, earlier, they used to grade the regular plan and its direct plan together. This is the right way to do it, and the regular plan option would always have lower starts than the corresponding direct plan option.

When they recategorised to align with SEBI rules, they decided to rank regular plans separately and direct plans separately within the same category. The problem is, ETFs do not have a regular or direct plan, and VR appears to be binning ETFs with regular plans – you can see this from their fund filters.

This is most likely why ICICI Pru Nifty Next 50 Index Fund Regular Plan has two stars and the direct plan only one star. So the lesson here is, star ratings entirely depend on how you group mutual funds.

One could group all active large cap funds, group all nifty index funds and ETFs together, all Nifty Next 50 index funds and so on for a homogenous set where comparisons are more meaningful.

Combining large cap active funds with large cap passive funds is not terribly wrong, but the investor should always remember the rating agencies are comparing one fund to another here. They are not comparing each fund with its benchmark.

Although we have shown earlier that Nifty Next 50 is much more volatile than active or passive large cap funds, it is ok to group them. We appreciate that the grading (star rating) is relative and not absolute.

So when ICICI Pru Nifty Next 50 Index Fund Direct Plan has a one-star rating, it simply means other direct plans funds in the group have done better in the last three year and five year period.

According to Value Research, the trailing three-year return rank of

• UTI Nifty Next 50 Direct Plan is 52nd out of 57 funds. (9.78%)
• ICICI Nifty Next 50 Direct Plan is 54 out of 57 funds.  (9.37%)

If we consider the volatility in NAV over the last three year period,

• UTI Nifty Next 50 Direct Plan ranks 34th most volatile out of 58 funds
• ICICI Nifty Next 50 Direct Plan rank 32nd most volatile out of 58 funds. However, the difference between the two is just 0.02%

The marginally higher return implies the UTI fund has a better risk-adjusted return score and, therefore, one-star more than the ICICI fund. This also depends on the other funds in the group, but there is not much to distinguish between the Nifty Next 50 funds.

The UTI fund does not have a five-year history at the time of writing. The five-year return rank of ICICI Nifty Next 50 fund direct plan is 43 out of 49. So it is not hard to imagine why it is only rated one-star today. This has nothing to do with how well the fund is tracking its index.

From early 2018 to March 2020, the stock market was extremely polarised. The top few Nifty 100 stocks (with dominant weights in the Nifty or Sensex) moved up, while the rest of the market, including Nifty Next 50 stocks, moved down. The imbalance was at an all-time high in Dec 2019, and the trend reversal began after the market recovery in 2020: Nifty 50 equal-weight index surges past Nifty 50 due to market rally.

The returns from Nifty 50 and Nifty Next 50 between 1st Mat 205 and 20th Aug 2021 (6+ years) is pretty much the same. Considering the higher volatility of Nifty Next 50, investors have not got a premium for the risk they have taken in this period.

The ICICI Nifty Next 50 fund was rated five stars in 2018 and early 2019. The different directions the two indices took from early 2018 to March 2020 can also be seen from the above graph. The situation has improved from last year: Should I switch my SIP in Nifty Next 50 to Nifty 50?

There is some distance to go for NIfty Next 50 to fire past Nifty, as seen recently: Is it game over for active large cap mutual funds?

What should investors in Nifty Next 50 do? Even if Nifty Next 50 does manage to beat the Nifty in the recent future, it is likely to frustrate similarly again. So those who think the reward is incommensurate to the risk can exit and shift to Nifty funds.

If you do not mind waiting for the Nifty Next 50 to recover (that is, if your needs are far away), then you can take a chance and stick with it. If you wish, you can increase exposure to NIfty 50/ Sensex. Those who stick with Nifty Next 50 should book profits to fixed income from time to time as part of portfolio rebalancing activity.

The future is unknown, and waiting is always a gamble (so is quitting on Nifty Next 50). For Nifty Next 50 to fire, the economy will have to recover better; the midcap and small cap stocks should soar higher than the NIfty (many Nifty Next 50 stocks are midcap-like in nature – at least from past data). This will take time. Also, see: Worried about Nifty Next 50 Index? What you need to know.