Feeling overwhelmed by the countless mutual fund options out there? You’re definitely not alone!
With so many choices, picking the right mutual funds for your financial goals is crucial, and star ratings help you do just that.
These ratings break down a fund’s past performance and risk levels into simple, easy-to-understand scores.
These ratings are similar to the stars we used to get on our homework – quick and clear, telling us exactly how well something performed.
In this article, we will cover all you need to know about star ratings in mutual funds.
Understanding Start Rating in Mutual Funds
Star ratings in mutual funds define the performance of funds against others in the same category.
These ratings range from 1 to 5 stars, with higher ratings indicating better historical performance than peers.
As a result, you can make informed decisions by comparing funds within the same category and then select the best mutual funds easily.
Based on these, here is what the star ratings denote:
| Stars | Performance | Risk | Return |
| 1 | Poor | High | Low potential |
| 2 | Below-average | Moderate to high | Below-average |
| 3 | Average | Moderate | Average |
| 4 | Above-average | Moderate to low | Higher potential |
| 5 | Top-tier | Low | Excellent |
How are Star Ratings Calculated?
The star rating system is based on various metrics and varies from agency to agency.
However, these ratings are not created in isolation – they are the result of extensive analysis of various factors unique to each agency’s framework.
Some agencies use risk-adjusted returns and past performance, while others focus on consistency, expense ratios, or even sector allocation trends.
This diversity in focus means no two ratings are identical, providing investors with a range of perspectives to consider.
Since there is no one-size-fits-all model for calculating star ratings, it’s important to evaluate funds beyond it and incorporate other factors such as your own risk appetite and financial goals.
Importance of Star Ratings to Investors
Star ratings simplify the investment decision-making process. This is very helpful for the beginners.
This acts as a guide on what to do when you are investing. The other reasons that make the ratings important are:
1. Benchmarking Performance
Star ratings offer a quick snapshot of how well a mutual fund has performed compared to its peers.
A higher star rating generally indicates better historical performance and risk management.
This can help you identify which fund to select from a list of funds available.
2. Simplifying Choices
The wide array of available mutual funds can be overwhelming for new investors.
Star ratings simplify this choice by highlighting funds that have historically performed well.
3. Risk Assessment
Star ratings take into account the risk-adjusted returns of funds.
This means that funds are not only evaluated on their returns but also on how much risk was taken to achieve those returns.
This can help investors find funds that align with their risk tolerance.
4. Historical Insights
While past performance does not indicate future results, star ratings provide insights into how funds have managed market fluctuations and their stability over time.
This historical perspective can be invaluable in assessing fund managers’ effectiveness.
5. Quality Indicator
Generally, funds with higher star ratings are perceived to have better management and investment processes.
This can be a significant factor for investors looking for quality investments.
Top 3 Star Rating Agencies You Should Know
When it comes to star ratings, various agencies work in this segment. The top ones that usually offer the star ratings to mutual funds are as follows:
1. Morningstar Ratings
It assesses mutual funds based on their risk-adjusted returns over 3, 5, and 10-year periods.
The top 10% of funds in each category are awarded 5 stars, with the ratings progressively decreasing to 1 star for the bottom 10%.
These ratings are updated monthly and reflect the most recent data. This makes them reliable for comparing a fund’s historical performance to its peers.
2. Value Research Ratings
It focuses on a fund’s performance over the last 3 and 5 years. It considers factors like volatility and consistency of returns. Funds are evaluated within specific categories.
This allows for direct comparisons among similar investment options. The ratings are distributed on a bell curve, explicitly highlighting the top and bottom performers.
3. CRISIL Ratings
It also uses a 1 to 5-star scale and evaluates mutual funds through quantitative metrics, including the Superior Return and Industry Risk Score.
This analysis spans 1, 3, and 5-year periods. It examines both returns and risks associated with each fund.
CRISIL’s ratings provide investors with deep insights into how well a fund has performed and managed risks compared to its category peers.
Top Mutual Funds by Star Ratings
Here are some examples of ⭐⭐⭐⭐⭐ rated funds (by Morningstar).
1. Nippon India Large Cap Fund ⭐⭐⭐⭐⭐
Focused on investing in large-cap companies with a proven track record and stable performance, it offers investors a blend of growth and stability by targeting established market leaders. Suitable for long-term wealth creation, it aims to deliver consistent returns with lower volatility.
2. Motilal Oswal Nasdaq 100 FoF ⭐⭐⭐⭐⭐
Providing exposure to top global technology and innovation-driven companies listed on Nasdaq, it is ideal for investors seeking international diversification and opportunities in high-growth sectors. The fund benefits from the performance of global tech giants.
3. SBI Long Term Equity Fund (Tax Saving) ⭐⭐⭐⭐⭐
An ELSS (Equity Linked Savings Scheme) fund that offers tax benefits under Section 80C while aiming for long-term capital appreciation. It primarily invests in equity and equity-related instruments, making it suitable for investors with a long-term horizon.
4. HDFC Balanced Advantage Fund ⭐⭐⭐⭐⭐
Designed to dynamically adjust equity and debt exposure based on market conditions, it balances risk and reward, making it suitable for investors looking for moderate risk with growth potential. A reliable choice for long-term financial goals.
5. Quantum Liquid Fund ⭐⭐⭐⭐⭐
Highly liquid and focused on capital preservation and liquidity, it invests in short-term, high-quality debt instruments, making it suitable for parking surplus funds. Ideal for investors seeking low-risk and quick access to their money.
Tips to Use Star Ratings
When using star ratings to choose mutual funds, consider these tips to improve your investment strategy:
- Do not solely rely on star ratings. Investigate the fund’s detailed reports and past performance.
- Choose funds that align with your investment goals, risk tolerance, and time horizon.
- Include funds with various ratings in your portfolio to tap into different investment strategies and market opportunities.
- Keep up with changes in fund performances and market conditions by regularly reviewing the ratings and your portfolio.
Conclusion
By distilling complex factors of mutual funds into a single score, star ratings simplifies decision-making, especially for those just starting their investment journey.
That said, star ratings can only act as a reference point for investors. Successful investments require a holistic approach that takes into account personal financial goals, market research, and ongoing adjustment of your investment choices.
