ABSOLUTE OR RELATIVE: THE DARK SIDE OF FUND RATING SYSTEMS

Emanuele Maria Carluccio (), Paolo Antonio Cucurachi () and Ugo Pomante ()
Additional contact information
Emanuele Maria Carluccio: University of Verona, Italy
Paolo Antonio Cucurachi: University of Salento, Italy
Ugo Pomante: Tor Vergata University of Rome, Italy

Journal of Financial Management, Markets and Institutions (JFMMI), 2023, vol. 11, issue 01, 1-30

Abstract: Academic literature and market practitioners have always devoted great attention to the analysis of asset management products, with particular regard to fund classification and performance metrics. Less attention has been paid to rating methodologies and to the risk of attributing positive ratings to underperforming asset managers. The most widespread rating criterion is the ordinal one, which is based on the assumption that the best asset managers are those who have performed better than their competitors regardless of their ability to achieve a given threshold (i.e. a positive overperformance against the benchmark). Our study, after a description of the most common risk-adjusted performance measures, introduces the idea of attributing the rating on a cardinal basis, setting in advance a given threshold that should be achieved to receive a positive evaluation (i.e. a rating equal to or higher than 3 on a scale of 1–5). The empirical test conducted on a sample of funds (belonging to the main equity and bond asset classes) made it possible to quantify the effects of the cardinal approach on the attribution of the rating and on the probability of assigning a good rating to underperforming funds. Empirical analysis also highlighted how the cardinal method allows, on average, better performance than the ordinal one even in an out-of-sample framework. The differences between the two methodologies are particularly remarkable in efficient markets such as the North American equity market. The two rating assignment systems were also analyzed using contingency tables to test the ability to anticipate the default event (underperformance relative to the benchmark). The policy suggestion emerging from our study concerns the significant impact of the rating criterion in reducing the risk of recommending funds that, despite a good rating, have failed to perform satisfactorily and are unlikely to do so in the future either.

Keywords: Mutual funds; performance evaluation; rating; persistence (search for similar items in EconPapers)
JEL-codes: G11 G23 (search for similar items in EconPapers)
Date: 2023
References: Add references at CitEc
Citations:

Downloads: (external link)
http://www.worldscientific.com/doi/abs/10.1142/S2282717X23500019
Open Access

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:wsi:jfmmix:v:11:y:2023:i:01:n:s2282717x23500019

Ordering information: This journal article can be ordered from

DOI: 10.1142/S2282717X23500019

Access Statistics for this article

Journal of Financial Management, Markets and Institutions (JFMMI) is currently edited by Santiago Carbo-Valverde

More articles in Journal of Financial Management, Markets and Institutions (JFMMI) from World Scientific Publishing Co. Pte. Ltd.
Bibliographic data for series maintained by Tai Tone Lim ().