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Mr Mehta is a careful investor. He believes in doing his homework before committing his hard-earned money. A month ago, he had decided to invest Rs 3 lakh in good quality mutual funds.

Consequently, as was his habit, he started looking up the available performance rankings of various funds in order to figure out which would be the best bets. However, a month later, he’s still at it without having been able to come to any conclusion.

If you have been investing in mutual funds, perhaps you too will identify with Mr Mehta’s dilemma. He just couldn’t find any consistency or consensus amongst rating agencies about their ranking of funds. The bewildering thing was that given the same set of numbers, different personal finance magazines, websites, broker reports and newspapers came up with differing conclusions as to which were the top ranked funds.

The reasons aren’t far to seek.
Essentially, the rating methodology adopted differs from agency to agency. In a bid to prove that they are special and more incisive than the next one, these agencies adopt all kinds of esoteric techniques and statistical tools to come up with dissimilar results.

As the saying goes, at the end of the day, numbers can be manipulated to get the results that you desire. So, pure performance-based analysis is only available in the minority. Most adopt risk-adjusted ratings, which would have been fine if the definition of risk, or more precisely, the statistical tool that best defines the concept of risk, was consistent.

However, this too differs from agency to agency. Some adopt the Sharpe ratio, some use the Sortino ratio and yet others look at standard deviation, beta and alpha. Then there are others who choose some specific parameters such as size of assets, portfolio turnover, tenure of the fund manager with the fund, fund size, expense ratio, etc. It does not end here. They then proceed to assign weights to each of these parameters to arrive at a composite ranking. Yet, there are others who declare that they use a proprietary system, which remains unknown to the public at large. I can go on and on describing various different and sometimes downright amusing ways in which funds are being rated, but I’m sure you have got the point already.

So what should an investor do?
Well, the fact of the matter is that most of these arcane rating methodologies are solutions in search of problems. Don’t ignore them totally. However, when you go through them, keep your pinch of salt ready.

Secondly, safely ignore all funds which haven’t been in operation for at least a year, which essentially means —- safely ignore one-month, three-month or six-month returns and rankings. I can go to the extent of saying look at only those funds that have existed for over three years. Not only will it eliminate a whole lot of “me too” upstarts, but also give you an idea about the sustainability of the returns of the fund.

Now that you have significantly reduced the sample size, try and find the common funds that come up in the top ten lists of the various agencies. In other words, arrive at the lowest common denominator. Remember, it is important that you invest with a well-managed fund. However, whether it is the top performing one or the second or the fifth matters little. Also, a topper today may come in fourth next year and so on. As long as you have invested in a quality portfolio that has stood the test of time, the particular ranking from any particular agency should matter little.

To give you an analogy, you know Virendra Sehwag or Yuvraj Singh are good batsmen. You don’t need anyone to tell you that. However, their ranks amongst the leading cricketers will differ as per the agency calibrating the performance. So, who cares if Yuvraj is fourth, sixth or tenth? His performance over the years tells me he is a good batsman and no one can argue with that.

Now use the same principle while choosing your mutual fund investment? No matter who the ratings are from, funds such as Reliance Growth, HDFC Equity, SBI Magnum Contra and Birla Sunlife Frontline Equity will almost always find a place in the top performers. And just like Sehwag having a lean patch doesn’t make him a lesser batsman, don’t get swayed by a three-month or a six-month performance number. Test of time is the only true test.

Last, but not the least, even after having identified and invested in a good mutual fund scheme, one other vital thing remains to be done. And that is, you need to remain invested. For example, the five-year return of HDFC Equity is 30.5% pa, whereas over a ten-year period, it has returned around 26% pa. To put it differently, Rs 1 lakh invested in this scheme would have grown to around Rs 3.78 lakh over a five-year time frame. The same investment, if held over the last decade, would have grown ten-fold to over Rs 10 lakh.

I am not suggesting that going ahead investors should expect similar returns. But for earning a return - any kind of return - holding the investment over the long-term is imperative.

To sum
It is as simple to earn healthy returns from your mutual fund investments as it is not to. Just do the basics right, invest with established diversified schemes with a good track record, let the money work hard and stay away from gimmicks. And last but not the least, take the following words of Donald Trump to heart — “Sometimes your best investments can well be the ones that you don’t make.”

The writer is director, Wonderland Consultants, a tax and financial planning firm.