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Is Quantum right here?

This one is a problem for you guys. Quantum AMC has an article in their July 07 newsletter saying thus:

Let’s take a normal school classroom.
During the mid-term exams, two students
Ram and Shyam scored 40% and 90%
respectively. It doesn’t take a genius to
figure out that Shyam (with 90%) is the
better performer. Now comes the fun part.
For the final exams, Ram scored 80% and
Shyam scored 95%. Who would you rank
as the better performer?

Shyam, of course! He scored 95 out of
a possible 100 while Ram scored only 80.
Yet, if Ram and Shyam were mutual
funds, and were ranked in the way mutual
funds are being evaluated, Ram (with 80%)
would have shown up as a great performer
while Shyam (with 95%) would have been
an underperformer and the laggard!

The logic behind the ranking of Mutual
Funds is that Ram, even though he has less
marks, has improved by 100% (from 40
to 80) while Shyam has improved only by
around 5.25% (from 90 to 95). By this
argument, the “best” mutual funds could
be those who have lost the most money
for their investors initially and not done
well, so that when they do recover lost
ground – as Ram did when his scores
jumped from 40% to 80% – they end up
as the “best performers”. That, dear
investor, is the potential flawed logic of
ranking mutual funds.

I think there is a serious flaw in this argument. I’ve mentioned in an earlier post about Quantum that I think this is completely ridiculous.

Firstly, mutual funds aren’t limited to 100%, are they?

Secondly, if the market moved up 35% in general, are we wrong to expect you to give us at least 35%? You are a no load, no commission fund, so the least I can expect is that you perform to the market’s expectations, no?

What they really intend is that investors should look at a “risk/return ratio”. There is something called the “sharpe ratio” which quantifies risk and return. Let me explain that in another post, but tell me if you also think the argument above is flawed, or if I’m just being silly.

P.S. I don’t want to sound too harsh on Quantum, but it gets my goat when they charge you 2.5%, give sub market returns, and have the gall to say other funds are expensive and that they shouldn’t be ranked.

  • Kamal says:

    >Quantum’s performance has been substandard to say the least in spite of so called superior products. And they shout hoarse about other MFs just as the IIPM does with regard to the IIM’s. Regardless of what they say, their results speak for themselves.
    Probably the one piece of advice everyone should heed to is to avoid NFO’s and invest in existing funds as NFO’s incur higher costs. The rest are just marketing gimmicks.

  • Siva says:

    >intersting question

  • Raj Gopal Vuppala says:

    >Deepak,
    I am not sure about what people at Quantum are saying but there is definitely some flaw in the way funds are compared these days purely based on returns.

    For instance couple of months back sometime at the end of June when I was checking the performance of mutual funds, DSPML Equity was ranked among the top 10 performing funds of the year in terms of return potraying a better performance than DSPML Tiger. But if you extend the picture by another two months and compare the overall performance over 14 months, it is no where even in the top quartile funds. The fund had a bigger drop in the May/June 2006 hence though its overall performance was mediacore, it one year ranks were very high. I don’t think the high rank given by most websites purely based on returns is justified and many times could be misleading.

    I try to compare funds from a fixed date rather than one year basis as it gives me a better picture. For instance, I create a portfolio on Valueresearchonline, having invested Rs.5000 in all the funds I am monitoring on May 10th 2006 (Peak before the correction) and then check the net returns of the funds from that date. This will give me a better idea of the performance of the funds.

  • Deepak Shenoy says:

    >Raj: Pure returns is just one way of ranking. You can rank by Sharpe ratio, which is a risk adjusted return number that can be compared across funds.

    The funda is, imagine you invested Rs. X in the fund on a certain date. Take the value of your investment on all subsequent days till today. each days variation from the mean (here the “mean” can be the “zero return” line, which is X) is then calculated, and statistical formulas applied to see how much better were you than the mean, and how much worse. This ratio is compared against all other funds.

    A fund that returns you 50% in a boom but goes down 50% in a downturn has exactly the same sharpe ratio as a fund that does 25% each way.

    You can use the sharpe ratio to compare, but Value research doesn’t compare unless teh fund has finished three years of operation.

  • Raj Gopal Vuppala says:

    >yHi Deepak,
    These days I have the instinctive urge to invest through SIP in high beta funds. Though they are more volatile,I think they can also offer better returns if invested systematicly. I am pondering investing in Taurus Starshare which is extremely volatile. What is your take on this.

  • Deepak Shenoy says:

    >Raj: of course, that’s a good prop if you can time it right. THere used to be a fund manager named Gil Blake in the 80s who would do exactly that – time entry and exit into equity funds.