Mutual Fund Ratings: What the Stars Really Mean

Ratings come from independent research and data firms. Each firm uses its own method. SEBI and AMFI do not rate funds, and a rating is not an official approval.

Different firms can give the same fund different ratings, because their methods differ. Our page on who regulates mutual funds explains the official bodies.

Most rating methods compare a fund with others in the same category over periods like three, five and ten years. They look at returns, but also at how bumpy the ride was. A fund that earned good returns with smaller swings scores higher than one that earned the same with wild swings.

The top slice of the category gets five stars, the bottom slice gets one, and the rest fall in between. Our page on Sharpe ratio and standard deviation explains risk-adjusted measures.

The biggest limitation is simple: ratings are built from past data. They tell you what happened, not what will happen. A fund that did very well in one market phase may struggle in the next.

This is why the familiar line says past performance may or may not be sustained in future. Our page on market risk disclaimers explains what that means.

Because ratings are updated regularly, funds move up and down. Investors who switch funds every time a rating changes end up chasing past winners, paying exit loads and tax, and often buying high.

Our page on switching mutual funds explains the costs of frequent changes.

A five-star small cap fund and a five-star liquid fund are not comparable. Each is rated against its own peers. A five-star small cap fund can still fall sharply in a bad year.

Always decide the category first, based on your goal and time frame, and only then compare funds within it. Our page on SEBI fund categories explains the groups.

Funds usually need a track record of a few years before they are rated. A new fund without a rating is not necessarily bad, and an old fund with a rating is not necessarily good. It just means there is not enough history to judge.

Our page on NFO versus existing fund explains how to think about new funds.

• Whether the fund manager who built the record still runs the fund.
• Whether the fund has grown so large that its strategy is harder to run.
• How much it overlaps with funds you already hold.
• Whether it suits your goal and time frame.
• The quality of the fund holdings today.

Ratings can be a useful first filter. Within a category, a fund that has stayed in the upper ratings for many years is worth a closer look. A fund that has been at the bottom for a long time deserves questions.

After that first filter, look deeper: compare with the benchmark, check rolling returns, read the fact sheet and understand the strategy. Our page on how to choose a mutual fund lists the checks.

A fund that has been reasonably good across many periods is often easier to live with than one that shot to the top briefly. Look at how long a fund has kept a good rating, not just its current stars.

Our page on rolling returns shows how to see consistency directly.

Not automatically. A drop from five to three stars may simply reflect one weak year or a market phase that did not suit the fund style. Look at the reasons and at a longer period before acting.

If a fund has lagged its benchmark and category for several years, that is a stronger reason to review it. Our page on when to sell a mutual fund gives a calm framework.

Do not confuse fund star ratings with credit ratings. Credit ratings, like AAA or AA, are given to bonds by credit rating agencies and show the borrower ability to repay. They matter a lot for debt funds.

Our page on debt funds explains how to read the credit quality of a debt fund holdings.

Apps often highlight top-rated funds, and fund houses mention strong ratings in advertisements. That is fine, but it means ratings are also a marketing tool. A highlighted fund is not necessarily the right fund for you.

1. Choose the category based on your goal and time frame.
2. Shortlist a few funds that have stayed in the upper ratings for several years.
3. Compare each with its benchmark over five years or more.
4. Check rolling returns, costs and how each behaved in falling markets.
5. Check overlap with what you already hold.

This takes a little more effort than picking the top star, but it leads to far more sensible choices.

A fund often reaches the top rating after a period when its style suited the market well. That success draws new money, and the fund grows larger. Market leadership then changes, and the same style may lag for a while. This cycle is common, which is why chasing the newest five-star fund rarely works well over time.

• Ratings come from research firms, not regulators.
• They are based on past risk-adjusted returns.
• They change often and do not predict the future.
• Use them as a filter, then look deeper.

We are distributors rather than investment advisers and we recommend no schemes. If you want help looking beyond the stars, get in touch.