3 Reasons to Avoid Generic Fund Ratings

CATEGORIES: Investment Analysis

3 Reasons to Avoid Generic Fund Ratings

Best small cap fund.” “5 top emerging markets funds.” You’ve seen them—the colorful headlines and accompanying lists of “the best” funds in some particular category. Are they the best funds for you? Here are 3 reasons why generic fund ratings are unlikely to be a useful source of investment research for you:

#1: There Is No “Average Investor”

One reason why those featured in generic fund ratings profiles are probably not best for you is that they don’t know who you are. Here’s a somewhat vivid illustration of the principle: imagine a person standing on a giant ice cube with his head just inches away from a furnace. Would we say that the person is comfortable because the “average” temperature in his location is a mild halfway between freezing and scorching? Of course not! But that’s effectively what the generic fund rating methodologies assume. They say there is one “average” investor type out there for which their top ranked funds are “best”. But that person doesn’t exist, and that person is certainly not you.

#2: There Is No Single Right Measure of “Best”

Generic fund ratings services typically use one single performance measure, like total return or risk-adjusted return, to define “best”. Occasionally they might present this single measure over more than one time period, like 3 years and 5 years, but little else. This is a flawed approach for two reasons. First, past performance is an unreliable indicator of future returns. You’ve heard that phrase time and again, and it is absolutely true. Second, performance is a composite of many different variables. Not only across multiple time periods, but across multiple market conditions and economic cycles. Other things matter besides risk and return—fee structures and sales expenses, tax considerations, manager tenure and fund correlation to its benchmark index are some of the important ones. And they matter to a different degree for each investor.

#3: What Matters to You Matters Less (Or More) to Someone Else

How much do you care about a fund’s total expense level? How about its ability to consistently generate income? Are you highly sensitive to how much the fund’s performance is prone to fluctuation over the next twelve months? Are you extremely averse to the tax consequences of the fund’s buying and selling decisions? The point is, if you put five investors in a room they are going to give five different answers to these questions. So how can one generically-rated fund be “best” for all five of them? It should be clear that the best fund for you is the one whose characteristics across all the relevant variables most closely align with the importance you attach to each of those variables.

To Be Relevant, Ratings Should Be Customized

The underlying principle of Jemstep’s approach to asset ranking is mass customization: that is to say, analyzing the entire universe of funds out there—over 18,000 mutual funds and more than 1,500 ETFs for starters—and customizing our rankings across multiple asset classes to align with the things each individual investor finds important. For a fund rating methodology to be relevant to you—you as a unique individual investor—it can’t fall back on lazy generic assumptions.

Tell us…What matters most to you in selecting investments?

 

Use Jemstep to find funds that really are best for you – not best for the “average investor” who doesn’t exist.

 

Subscribe via RSS

Sending...
Thanks for subscribing
There was a problem, please try again

About the Author

Katrina Lamb is a CFA for Jemstep. She has over 25 years experience in economics, finance, international development and management strategy, with a strong focus on global markets. She provides a voice of clarity, logic, and reason in an environment characterized by high uncertainty.

TAGS: ,

Leave a Reply

Your email address will not be published. Required fields are marked *

* Copy This Password *

* Type Or Paste Password Here *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>