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Beware, Mutual Fund rankings cannot be applied blindly

Investors are generally averse to working hard. They rarely do any meaningful due diligence before making any investments. Therefore, they are always on the look out for shortcuts.

Accordingly, when it comes to investing in the mutual funds, the fund rankings make life really simple. They simply choose a few "top rated" funds and feel happy about it.

Independent and reputed companies such as CRISIL, Morningstar, Valueresearchonline, Moneycontrol.com etc. offer unbiased opinion. Hence, there is no denying that their mutual fund rankings carry a lot of credibility.

Moreover, these rankings take into account not only the performance delivered by various mutual funds, but also consider the portfolio characteristics, risk profile and other relevant parameters of the underlying assets. [See 'Mutual Fund CRISIL Ranking']

As such, these mutual fund rankings are undoubtedly a great tool for the lay investors.

However, beware!

While there is nothing wrong with these fund rankings and they are really important too, blindly applying them would certainly be a very bad idea.

Be very careful in applying the mutual fund rankings to select your funds.

One obvious reason is that the ranking is based on past performance. 

Whereas your returns would be determined by how the future unfolds: 

For example, given the policy paralysis under the previous Govt., infrastructure projects suffered a serious setback. Consequently, about a year ago, infrastructure funds were the worst of the lot. Yet, with the change in the Govt. and expectations of improvement in the economy, these funds been out-performers in the recent months.

Another common instance is when a highly-ranked popular fund attracts huge inflows; such that its AUM soon balloons to unwieldy proportions. As the fund grows "very" large, its ability to outperform the market could progressively reduce vis-a-vis say a medium-sized fund. In such a scenario, a lower-ranked medium-sized could possibly deliver better returns than a higher-ranked but extremely large-sized fund.

Yet another example of how you can go horribly wrong, if you unintelligently use these rankings in fund selection, becomes clearly evident with the debt funds.

Debt funds, as you would be aware, are susceptible to interest rate risk

When the interest rates are rising, debt funds will underperform (even to the extent of giving negative returns, if the rate appreciation is sharp and swift). Vice versa, in the falling interest rate market, these funds may outperform even the equity funds. This volatility is more pronounced in long-term debt funds (typically referred to as 'income' funds).

Therefore, when the rates are say at the peak after a sustained uptrend, income funds would have delivered the worst performance and their ranking would be at the lowest. Yet, this probably would be the best time to invest in income funds (provided there are indications of a trend reversal with interest rates heading south going forward).

On the same lines, at the bottom of the interest rate cycle, income funds would be ranked the best. Yet, with the likely upturn in the interest rates, their future would indeed be bleak...  indeed very bleak.

There cannot be a more contrasting example than this when mutual fund rankings would be the worst indicator in choosing your funds.

Concluding... reckless use of mutual fund rankings could prove damaging. So apply them only after proper thought and due consideration of the economic scenario around you.

An Investment In Knowledge Pays The Best Interest ~ Benjamin Franklin

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