Fund Rating Methodology PDF

Value Research Fund Rating is a convenient composite measure of both returns and risk. This single measure combines Value Research Fund Return Grade and Value Research Fund Risk Grade, indicating a fund’s risk-adjusted performance within its category. The rating is purely quantitative, with no subjective inputs. It is a unified performance measure and summarises how a fund has historically performed relative to peers, adjusted for the risks it has taken.

Overall Rating Framework

For all funds in a category:

• Individual Return Scores and Risk Scores are calculated.
• The fund’s Risk Score is then subtracted from its Return Score to arrive at a composite risk-adjusted performance measure that forms the basis for rating.

• The scores for two time periods are combined to give a single assessment of each fund’s standing within its category.

  For equity and hybrid funds, a 60 per cent weight is assigned to the five-year score and a 40 per cent weight to the three-year score to arrive at the aggregate score. In the case of debt funds, the time periods considered are – three years (60 per cent weight) and 18 months (40 per cent weight). Funds without a five-year / three-year history are evaluated solely on their three-year / 18 months score.

The resulting composite scores are then translated into a star rating based on the following distribution:

Rating Cap for Debt Funds

For debt funds, the overall rating is subject to rating caps designed to limit ratings for portfolios exhibiting elevated structural risk.

A debt fund’s rating may be capped if it breaches predefined tolerance thresholds for:

• Credit risk, or
• Issuer concentration risk

If such a breach occurs in any of the last three months, the fund’s rating is capped accordingly, regardless of its composite score. This ensures that portfolio-level risks are reflected promptly in the rating outcome, addressing the unique nature of fixed-income investing.

Because of these caps, rating distributions for debt funds may not always follow a normal curve. In certain months or categories, there may be no 4-star or 5-star rated funds. The absence of higher-rated funds reflects risk controls rather than a deficiency in performance outcome.

Value Research Fund Return Grade

Value Research Fund Return Grade measures a fund’s performance relative to its peers after adjusting for the risk-free return.

Monthly returns are evaluated in the case of equity and hybrid funds while weekly returns are taken for debt funds. The risk-free return is defined as the State Bank of India’s 45–180 days term deposit rate.

For each period:

• The fund’s return in excess of the risk-free return is calculated.
• The fund’s average excess return is compared with the category average to derive a Return Score. If the category average return is negative, the risk-free return is used as the benchmark instead.

The weighted average Return Score of a fund is then assigned a grade according to the following distribution:

Additionally, following adjustments are done in the case of debt funds:

• Adjustment for credit quality: Return Score for debt funds explicitly incorporates portfolio’s credit quality.

  This allows returns to be evaluated after adjusting for the credit risk taken, ensuring that any excess returns emerging purely from lower credit quality are normalised.

  For each period, expected extra yield derived from the fund's average credit exposure is subtracted from the fund’s average excess return over the risk-free return. The resulting credit-adjusted excess return is compared with the category average to derive a Return Score as per the above framework.

  As a result, a debt fund with relatively modest returns but high credit quality may receive a stronger Return Grade than a fund with higher raw returns driven by elevated credit risk.

• Normalising returns for recovery proceeds: In cases where a debt fund’s returns are inflated due to recovery proceeds from previously written-off securities, such gains are normalised. This adjustment prevents one-off recoveries from causing an abrupt, unwarranted change in ratings.

Value Research Fund Risk Grade

Value Research Fund Risk Grade captures the fund’s risk of loss. It is different from the conventional risk and volatility measures such as standard deviation or beta.

The focus is on downside risk—absolute losses or periods where the fund underperforms the risk-free return. The rationale is straightforward: investors can always earn a guaranteed return by investing in a risk-free instrument such as a bank term deposit. The true risk of a mutual fund lies not just in capital loss, but also in earning less than this guaranteed alternative.

For each period, monthly or weekly fund returns are compared against the risk-free returns, and the magnitude of underperformance is aggregated. The average underperformance relative to the fund’s category is expressed as a Risk Score.

The weighted average Risk Score is then mapped to a Risk Grade as per the following distribution:

Where a debt fund’s rating is subject to a rating cap, its Risk Grade reflects the higher of the two risks – Risk Grade derived from the fund’s Risk Score, or the Risk Grade implied by the capped rating (lower capped ratings correspond to higher Risk Grades). For instance, if a fund’s Risk Score classifies it as “Above Average”, but its overall rating is capped at 1-star due to elevated portfolio risk, the fund’s Risk Grade will be “High”.

Cases when a Fund is not Rated

• Value Research does not rate an equity or a hybrid fund with less than three years of performance history and a debt fund with less than 18 months of performance track record.
• Each category must have a minimum of 10 funds for it to be rated.
• A fund with less than Rs 5 crore of average assets under management over the past six months is not eligible for rating.
• Categories where funds aren’t comparable or don’t form a homogeneous set, ratings aren’t calculated.
• We don’t rate ETFs, as their NAV-based performance may not reflect actual investor experience.
• Funds that have undergone a recent material change in investment objective, rendering their past performance irrelevant in the context of peers, are not rated.

You may read the rating FAQ document for further clarification.