How to get the most out of fund ratings

A growing number of investors are managing their own money following the revolutionary changes in the financial advisory industry that resulted from the Retail Distribution Review (RDR).

These reforms have left many investors reliant on their own resources, although there are others who simply prefer to run their money themselves.

To help you make better decisions, FE has developed a series of ratings that are independently derived through quantitative measures – meaning they are not based on opinion, but on cold, hard numbers.

Here we look at some key features of these ratings and how to use them when building a portfolio.


What are FE Crown ratings?

The FE Crown Fund Ratings are based on quantitative analysis, not opinion, and rank funds from one to five.

The ratings take in to account three key measurements to gauge a fund’s performance: alpha, volatility and consistency of returns.

The alpha is the value a fund adds to its benchmark, or the difference between the gains the fund makes and the gains the investor would have made by simply investing in the benchmark.

Volatility refers to how sharply the fund's returns differ over time, with lower volatility considered lower risk and therefore better.

Much importance is placed on the consistency of outperformance when deciding upon the rankings.

They are based on historical performance relative to an appropriate benchmark, chosen by FE.

One of the key advantages of the rankings is that they measure the fund relative to its own benchmark. On FE Trustnet, you will find tables of the top-performing funds in each sector, but these will not always provide a fair comparison.

Sectors can contain funds with widely different objectives and strategies, meaning that it isn’t really meaningful to compare them against each other. FE’s research team conducts the analysis to find the most appropriate benchmark against which the fund should be measured.

Very occasionally, funds are not given a ranking if a suitable benchmark cannot be found. Otherwise, if a fund does not have a ranking, it is almost certainly because it does not have a three-year track record.

The top 10 per cent of funds are awarded five FE Crowns, the next 15 per cent four FE Crowns and each of the remaining three quartiles will be given three, two and one FE Crown respectively.

The ratings are rebalanced every six months, in February and August, which means you need to keep an eye on any changes, as a lot can happen in half a year.


How should I use them?

The rankings allow you to see at a glance the funds that have done the best over the previous three years, giving you an idea of where to look once you have your asset allocation sorted out.

However, you need to bear in mind that three years is not very long. In fact, it is the minimum amount of time that most advisers would look at before recommending a fund, and some would want to see five or seven years’ history.

It is a good idea to look at the longer track record, too, to make sure that the recent outperformance isn’t out of character.

At the same time, it is important to remember that the ratings are based on historical data, or what the fund did in the past. There is no guarantee that the past outperformance will continue. Some funds consistently outperform their benchmark, while others outperform for a few years and then underperform.