In some cases, why does a regular plan have a higher rating than a direct plan? For example, Axis Midcap – Regular has a higher rating than its Direct counterpart. Why should the rating of the same fund be different?
- The reader who wrote in did not wish his name to be disclosed.
The star ratings of Morningstar are a quantitative assessment of a fund’s past performance - both return and risk - as measured from 1 to 5 stars.
The Rating is based on the Morningstar Risk-Adjusted Return, or MRAR. To calculate the 3-year MRAR of a fund, a string of 36 months' returns are taken and each monthly return is adjusted for sales loads, excess over the risk-free benchmark, and risk. The adjusted monthly returns are expressed as an annualized figure and repeated for 5- and 10-year periods.
Here’s how it is arrived at.
- The star rating is awarded to each fund for 3, 5 and 10 years periods individually. This is based on a normal distribution of ratings on a 5-point scale.
- The overall aggregate star rating is arrived at using a weighted average star rating for 3-, 5- and 10-year periods as follows:
| Fund Tenor |
3-year MRAR |
5-year MRAR |
10-year MRAR |
| >10 years |
20% |
30% |
50% |
| 5 -10 years |
40% |
60% |
NA |
| < 5 years |
100% |
NA |
NA |
In the specific cases that you have highlighted, the direct plans have a different star rating, purely because their star rating will be arrived at only using the 3-year MRAR (given that their vintage is less than 5 years).
Another reason for direct share classes receiving a different star rating can also be attributed to the fact that the star rating is done on a normal curve distribution. There may be specific instances where the 0.8-1% return differential from the regular share class may cause the direct share class to be at different star rating bucket.
Intuitively, a direct plan should have the same, if not higher, rating as compared to the regular plan. However, this will be normalized once direct plans have been in existence for a longer time period. Right now there will be peculiar cases like the one you pointed out for funds that have done relatively a lot better in the peer group on, say, a 5- or 10- year basis as compared to on a 3-year basis. This is purely a function of the weighted average calculation methodology of the overall star rating basis the 3-, 5- and 10-year star ratings.
To cite the example you brought up, in the case of Axis Midcap, both the regular and direct plans are 2-star on a 3-year basis, but the regular plan is 3-star on a 5-year basis. Thus the weighted average star rating of the regular plan is 3-star (2.6 rounded up to 3).
To make a fair comparison between direct and regular plans, one could perhaps refer to the 3-year star rating as opposed to the overall star rating.
