Modified Sharpe Ratio Application in Calculation of Mutual Fund Star Ranking

Abstract

Purpose of this study is to apply to modify Sharpe Ratio to calculate Star Ranking of Equity-based mutual funds registered in Mutual Fund Association of Pakistan, further, the idea was to recalibrate locally developed models being used in Pakistan by autonomous professional bodies who professionally assigns star ranking of mutual funds, equity market exhibited negative returns from July 2017 onwards this research which brought the problem to assign star ranking due to model structure, model relies on risk-adjusted return (Sharpe Ratio), therefore Sharpe Ratio has a limitation in negative excess return. Two developed models were simultaneously compared to witness the predictive power of these models, (1) modified Sharpe and (2) VIS Credit Rating Company (Explaining the Stars) Model. Data was collected from March 2013 to March 2018 quarterly and the exercise was done quarterly. Findings revealed a magnificent piece of work, (1) there is no difference between model 1 and model 2 by both way results exhibited same mutual fund star rankings, (2) both methods have a different way of calculating final score with same results, and (3) modified Sharpe ratio is quite well when excess return is negative but when there is a mix of negative and positive better to use VIS model as well as in positive excess returns. A research paper could not calibrate other models developed by rating companies (Pakistan Credit Rating Company) which is a future research gap.