Both direct and regular plans are rated separately and the difference in risk-adjusted performance within their respective sets leads to different rating, explains Dhirendra Kumar
Could you please explain why some mutual fund schemes' regular plans have better star ratings than direct plans of the same schemes?
- Mira Berry
Yes, I was looking for an opportunity to explain it and your question has provided me with just that. We rate mutual funds within various categories and our mutual fund rating system is a relative rating system. When you see a 5-star rating, it is a 5-star fund in its own category and relative to all other funds in the category. So, between a 5-star fund and a 4-star fund, the latter has generated lower risk-adjusted returns as compared to the ones generated by the former one.
And we rate the regular plans as a separate unique set as compared to the direct ones because that is how investors actually go about choosing one i.e. either an intermediary is selling you a mutual fund or you are evaluating the fund yourself and then you are only looking at the direct plan. Besides, the expense is another factor that is taken into consideration, as the risk-adjusted performance on a relative basis of regular plans and direct plans can be different. There is a possibility wherein there could be a regular plan of a mutual fund which is 5-star simply because it is better than all other funds in the category. The direct plan of the same fund can have lower risk-adjusted performance as compared to some direct plans of other funds in the same category and hence, may have a lower rating.
So, it is a comparison between direct plans of the same category and regular plans of the same category and that is how investors select funds. You are either choosing from a universe of direct plans or you are being served a fund from regular ones. Because of the difference in expenses, the relative performance of the funds compared to other funds in the same category can vary, which leads to this difference in rating.