Our Debt Mutual Fund Rankings Framework

In the world of investing, if equity is the engine that provides speed, debt is the braking system and the suspension that provides stability. However, for a distributor, explaining debt funds is often more complex than equity. While equity revolves around growth, debt is a delicate balancing act between Liquidity, Safety, and Yield. We talk about debt funds in detail here: Decoding Debt Mutual Funds (Part 1 – The Basics).

At Creso, we believe in empowering our sub-distributors with objective, data-driven insights. Following the Phase I and Phase II of our Mutual Fund Ranking Framework focused on equity and hybrid mutual funds respectively, we have extended this to the Debt mutual fund category; in Phase III of our ranking exercise.

The Core Pillars of our Methodology

Unlike equity funds, where we look for "alpha" (outperformance), our debt framework is designed to identify "consistency" and "risk-mitigation", besides outperformance. Our debt ranking framework is built on the same three pillars that define our equity & hybrid rankings, ensuring consistency in how you communicate value to your clients.

1. Fund & Management Quality (~25% Weight)

We believe that the "ingredients" of a fund - its costs and the experience of its pilot - are lead indicators of long-term success.

• Expense Ratio: Lower costs lead to better compounding. We reward funds that maintain competitive expense ratios relative to their category peers. This factor gets bulk of the weightage in our methodology

• Lead Manager Vintage: Debt funds require relative lower active decision-making, as compared to active equity and hybrid funds. We prioritize funds where the lead manager has a proven track record of navigating different market cycles.

2. Performance Consistency (~35% Weight)

Instead of point-to-point returns which can be misleading due to "recency bias," we focus on Rolling Returns.

• 3-Year & 5-Year Rolling Returns: We evaluate how a fund has performed across multiple entry and exit points. A fund that consistently stays in the top two quartiles of its category is ranked higher than one that fluctuates wildly between top and bottom.

• Relative Performance: We measure a fund’s ability to outperform its specific category benchmark, ensuring that the "alpha" generated is genuine and not just a result of a rising tide lifting all boats.

3. Risk-Reward Efficiency (~40% Weight)

The largest weightage is given to how efficiently a fund manages risk. In the debt space, protecting the downside is more important than capturing the upside.

• Sortino Ratio: This metric helps us understand if the extra returns a fund generates are worth the downside risk taken ("bad" volatility).

• Modified Duration (The Interest Rate Sensitivity): We track how sensitive a fund is to interest rate changes. We evaluate whether the modified duration is aligned with the sub-category and objectives of the fund. A higher than appropriate modified duration generally means slightly more volatile movements in response to interest rate changes whereas a lower than appropriate modified duration implies the fund won’t participate much in interest rate cycle changes.

• Credit Quality (The Safety Net): We analyze the underlying ratings (AAA, AA, A, etc.) to ensure the fund isn't taking excessive risks to juice up returns. We have penalised fund with weaker average credit quality and also funds that have holdings in lower quality securities (despite average rating being high).

*The weightages presented above indicate a broad average across sub-categories and vary among them.

Applying the Methodology Across Sub-Categories

SEBI classifies debt funds into multiple sub-categories based on duration and issuer type. Our ranking framework applies specific "weightage filters" depending on the category’s objective.

1. Cash Management Tier (Overnight & Liquid Funds)

For these categories, relative performance and expense ratios carry the highest weightage in our ranking.

2. Short-Term Accrual Tier (Ultra Short, Low Duration, Money Market, Short Duration)

Our framework evaluates the Modified Duration and Average Credit Quality, besides relative performance and expense ratios. Weaker average credit quality gets punished through relatively lower score.

3. Core Corporate & Banking Tier (Corporate Bond, Banking & PSU)

These funds are mandated to invest in high-quality instruments. In this tier, we consider Sortino ratio as a key evaluation metric and any exposure to weak credit quality results in a penalty to the overall score.

4. The High-Yield Tier (Credit Risk Funds)

A Credit Risk fund is ranked not just on its high returns, but on the fund manager’s ability to avoid defaults. As a result, any tilt towards weak credit quality attracts a penal score. Sortino ratio remains a key evaluation metric in this tier as well. We have also disqualified certain funds that received one-off past recoveries, causing inflated returns.

5. Duration & Gilt Tier (Dynamic Bond, Gilt, Medium to Long Duration)

These funds are plays on interest rate cycles. Our framework compares the fund’s sensitivity to interest rate movements (using Modified Duration), while the Sortino ratio helps to evaluate excess return per unit of downside risk undertaken.

Filters and Eligibility Criteria

To maintain relevance and reliability, the following filters are applied before ranking:

• Minimum fund age requirement of 3-years, ensuring adequate performance history

• Minimum AUM size of ₹500 crores for all sub-categories of debt funds except liquid fund wherein ₹5,000 crores threshold has been adopted

• Plan-level evaluation - plans are evaluated consistently (regular + growth option), without mixing plan types

• Category-wise ranking, so funds are compared only against true peers

These filters ensure the rankings remain fair, comparable, and actionable. These filters matter. A 2-year-old fund has never been through a full rate cycle. A ₹50 crore fund can see massive NAV swings from a single institutional redemption. Mixing regular and direct plans would make comparisons meaningless (direct plans have lower expense ratios by design, not by superior management).

Scoring and Ranking Process

Each parameter within a pillar is scored on predefined ranges. The weighted scores across all parameters are aggregated to arrive at a final composite score for every fund within its category. Funds are then ranked within their respective equity categories, ensuring no cross-category distortion and apples-to-apples comparison for investors and distributors.

While our ranking framework is derived using a rules-based methodology, the Creso team has reviewed the results and made appropriate tweaks, without overriding the core methodology to ensure consistent and reliable rankings.

How to Use These Rankings with Your Clients

As a sub-distributor, these rankings are your "Technical Factsheet." When a client asks why you are recommending a Rank 1 fund over a competitor's top-performer, you can use the following logic:

• "It’s not just about the 0.5% extra return; it's about how that return is earned." Use our framework to show them the higher credit quality of your recommendation.

• Matching Horizon to Duration: Ensure the client's investment horizon matches the category. For a 6-month goal, look at our Rank 1 or 2 funds in the Ultra-Short Duration category.

• Avoiding "Duration Mismatch": In a rising interest rate environment, our framework will automatically downgrade funds with a higher than appropriate duration. This helps you protect your clients from capital erosion.

The rankings should always be used in conjunction with investor goals, risk tolerance, and asset allocation requirements.

 By following the Creso Debt Ranking Framework, you aren't just selling a product; you are providing a Risk-Managed Solution. This builds long-term trust, which is the most valuable asset in the distribution business.

 For a detailed look at the current rankings across debt sub-categories, login to the Creso Partners portal.