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BW Businessworld

Methodolgy: How We Did It

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In a year that saw mutual fund companies mop up a record Rs 1,94,096 crore through 1,102 new schemes, the BW-Value Research study of the industry presents you with a shortlist of the 100 best mutual funds.
To ensure a mix of several types, we have identified the best funds in six different categories. Thirty of the mutual funds in the list are diversified equity funds (excluding thematic and midcap); 20 are aggressive equity funds (mid-cap, small-cap, thematic); 15 each are balanced funds (debt and equity) and debt funds (medium-term debt and gilt funds); 10 are debt-oriented hybrid funds (Monthly Income Plans or MIPs) and 10 are short-term debt funds (cash and liquid funds).
For a meaningful assessment based on risk-adjusted returns, only equity and hybrid funds operating for a minimum of three years and fixed income funds with a minimum history of 18 months have been included in the study. This gave us a universe of 1,644 funds.

The methodology used to rank these is largely quantitative. It is based on the principle of risk-adjusted returns but widened to take a composite measure of the returns a fund generates and the risk it takes to do so. The concepts used in the study are explained below:
Risk: To calculate risk, monthly/weekly returns are compared with monthly risk-free returns for equity and hybrid funds and weekly risk-free returns for debt funds. A risk-free return is the State Bank of India’s 45-180 days term deposit rate. For all months/weeks that the fund has underperformed the risk-free return, the magnitude of under-performance is added. This gives the average underperformance, which is ranked along with those of other funds of the same type and a relative risk score is thereby assigned.
Returns: The monthly/weekly returns of each fund (adjusted for dividend, bonus or rights) are compared with the mon-thly/weekly risk-free return to arrive at the fund’s total returns in excess of the risk-free return. The monthly average risk-adjusted return is then compared with the average category return to arrive at a return score. In case of a negative category average return, the risk-free return is used as benchmark. The returns are then ranked along with those of other funds of the same type and a relative return score assigned. All return computations assume reinvestment of dividend and are adjusted for any bonus or rights. All trailing returns for a period of over one year are annualised.
Sharpe ratio: A measure of the fund’s risk-adjusted returns per unit of risk assumed. It is calculated by deducting the risk-free rate of return from the average monthly return and dividing it by its standard deviation. The higher the Sharpe ratio, the better the fund’s historical risk-adjusted performance.
Asset size: The total assets being managed by the fund as of 31 January 2008. Finally, a composite risk-return score was obtained by subtracting the risk score from the returns score. This composite score was used to select the top 100 funds and to rank the selected funds. To facilitate comparison, the composite score of each category was normalised to a scale of 1 to 10. All data for the study is as of January 31, 2008.
SIP: Systematic investment plan is a method of investing a fixed sum, on a regular basis, in a mutual fund scheme. It is similar to regular saving schemes such as a recurring deposit. A SIP allows one to buy units on a given date each month. They help averaging out of investment over the bull and bear cycles. Typically, liquid funds, cash funds and floating rate debt funds do not offer SIPs.
NAV: Net asset value is the current price of every unit of a fund.
Entry load: Fee paid while entering a mutual fund. Investors dealing directly with the company do not pay an entry load.
Exit load: Fee paid while exiting a mutual fund. The fee ranges from 4 per cent to 0 per cent.
Open ended: A fund that can issue and redeem shares at any time. Fund companies create new shares for investors on the fly.
Closed ended: Shares are normally redeemed when the fund liquidates. New shares are rarely issued after the launch. Fund price is determined partly by the value of the investments, and partly by the premium/discount on it.
(Businessworld Issue 25 Feb-3 Mar 2008)