Larissa Fernand: Welcome to Morningstar. I'm Larissa, the Editor. Joining me today is Kaustubh Belapurkar, the Director of Fund Research.
Thanks for being here, Kaustubh.
Kaustubh Belapurkar: Thank you so much, Larissa.
Fernand: Kaustubh, your fund research team comes out with two ratings, the Star Rating and the Analyst Rating. Could you explain the difference between the two so investors can get some clarity?
Belapurkar: Sure. I think it's very important to articulate the difference between these two ratings. So, if you look at the Star ratings, they are predominantly quantitative backward-looking ratings on the historical performance of the manager's returns. The Analyst ratings is a more forward-looking assessment of the manager on the way we expect the manager to perform on a long-term going forward. So, to put it simply, the Star ratings are what we call an achievement test and the Analyst ratings are what we call an aptitude test.
Fernand: Morningstar is known for its qualitative ratings which is fairly uncommon in India. So, could you take us through the process which explains the fund manager, his team, the AMC in general?
Belapurkar: Sure. Quantitative ratings per se have the inherent problem of being very backward-looking. The problem for them is twofold. One is, you don't know how and why the returns have been generated and secondly, are they going to be sustainable going forward? And that's where really Morningstar comes in with their global philosophy of the five pillars or what we call the 5 Ps, which are, people, process, parent, performance and price.
Just talking a little more about these pillars, the people pillar is really where we want to assess A, the pedigree of the manager, but just not that, also look at the team that's supporting him in building up the portfolios. We look at the capacity of the manager because clearly that's something that can be a concern if he is managing a lot of assets across diverse strategies and obviously, the longevity of the team is important because if you have a cohesive team that's working together, there's something going right with the investment process.
If I move on to the process pillar really, that's where we're trying to assess where is the strength of the asset manager in terms of actually coming out of the best investment ideas, what is the investment decision-making process and how does that really flow into the portfolio construction. That's another very crucial pillar for us to understand.
The third one, which is, I think very uncommon in the Indian market is the parent pillar where we try to assess the asset manager on the right set of practices that they would be following. For instance, the fund manager compensation. What we really trying to understand here is how are the manager is being compensated in terms of fund performance. Is it based on short-term or long-term performance? What we would really like to see is long-term performance rather than short-term being awarded because that's where then the manager's interests are aligned with that of the investor.
We will also then look at other factors like is the asset manager looking at gathering new assets or actually servicing the existing investors. That's some of the aspects that we would look at when we are looking at the parent rating.
Fernand: So, you also mentioned two other Ps, performance and price. So, can you touch upon that too?
Belapurkar: Sure. So, performance, I think, is a screener that most people use in the industry but unfortunately it's a very myopic view that a lot of people tend to take. And I'll explain where I'm coming from. So, typically, point-to-point short-term returns are what investors tend to look at and make their investments in funds.
Like I had highlighted earlier, this is something which may or may not always work because what you really need to understand is how have these returns been delivered by the manager and again, how sustainable are they going forward. You need to get down to a portfolio attribution of the performance to understand is it coming from a few stocks or is it actually a more diversified set of stocks and sectors that are delivering the returns. You would tend to look at the way the fund is performing across market cycles. You'd want a fund that does reasonably well in both up-trending and a down-trending market. So that's really on the performance side where there's a more deep dive into rather than just looking at the final output which is the returns that people tend to look at.
The price is again – the Indian market obviously we see is priced at slightly higher end as compared to the global peers but even there, there are some distinctions between funds where the pricing could vary. So it's more of a hygiene factor right now in the Indian market to understand because obviously a more expensive fund would work to the disadvantage of investors. That's another pillar that we would tend to look at closely.
Fernand: Great. Thanks Kaustubh. That was very detailed. But I'd like to know how an investor can use these ratings?
Belapurkar: Sure. So, I think an investor clearly needs to understand that these ratings are forward-looking and for a long-term investment horizon. Like we know that the equity markets and the debt markets would go through their ups and downs. Similarly, fund managers will have some low periods along with their up periods. So, it's important to acknowledge that it's impossible for a manager to perform day in and day out and remain at the top of the time. There will be times when his calls may or may not go right. But how does he actually go ahead and course correct, that's important for us to understand and that's really how we go ahead and assess managers.
To give you an example, if he is invested in a stock or a sector, which hasn't been doing so well because the market A, probably doesn't acknowledge the idea for the time being, does he hold on to his – as long as he holds on to the stock even if his investment thesis is still true then that's something that we like in a portfolio manager. At the same time, if a stock runs up and the valuation looks very rich, he should have the sell discipline of pruning his exposure. So that's something that we really need to look at when we are rating a manager.
So, in a similar fashion, the investor needs to understand that if we have a top-rated strategy the fund could be underperforming for a short while, but as long as he is patient and he is invested in good strategy, it is going to reap him benefits over the long term.
Fernand: Okay. I get it. But it leads me to the next question. How often do you revisit the analyst rating that you give?
Belapurkar: So, we typically tend to look at it at least on an annual basis. Since it's a more qualitative forward-looking assessment, we don't believe that anything would materially change over a one-year period. But that said, if there are some changes at, say for instance, a fund manager change happens or a very key resource within the asset manager leaves, for instance, a CIO leaving, would be a trigger for us to go and meet the fund management team again to understand the way forward.
The other triggers that could work for us are, for instance, if there is a major deviation in price in terms of performance, we would want to assess what's happening. I'm not saying that we would go ahead and change our rating, but yes, we'll be cognizant that we need to understand what's really resulting in a performance that's above or below the benchmark and the peer group.
Fernand: Okay. Great. Thanks. Kaustubh, thank you so much for your time. This is Larissa for Morningstar. Thank you for listening.