This is an ad from T.Rowe Price promoting their retirement funds. But ads like these are all too common in the mutual fund industry. Open any business or investing magazine and you’ll find all sorts of metrics based around Lipper. Lipper ranks, Lipper leaders, Lipper indexes, Lipper Fund Awards… But then what do they mean and how are these different from, say the market benchmark, the S&P 500 index?
Lipper is a fund analytics company that’s been in business since 1973. It was started by a Securities Analyst, A. Michael Lipper, but was sold to Thomson Reuters in 1998. Lipper monitors and benchmarks active mutual funds, and now even ETFs, based on a number of criteria not just annual returns.
The most common metric used by Mutual Fund companies is the Lipper Average. This is the average annual return of a fund among its peers, within a particular category, as categorized by Lipper. If a particular fund scored better than the average in its category, fund companies highlight this fact to promote the fund.
In the above ad, T Rowe Price is highlighting the fact that all the funds in their Retirement Portfolio, beat their 5 year Lipper Average.
Here’s another ad from Invesco promoting their Balanced Risk Allocation Fund, ranked 2 percentile of Lipper’s Global Flexible Portfolio. Lipper Rank can be expressed as a percentile or in absolute numbers. In the above ad, Invesco has published both. This particular fund is in the 2nd percentile, 3rd out of 235 funds, in the Global Flexible Portfolio category.
Rankings are calculated for 1, 3 or 5 years among peers for a specific asset classification (small cap, large cap, emerging markets etc.).
Lipper groups funds into five categories.
- Mixed Equity
- Fixed Income &
- Money Market
From the above, funds are further classified based on the type. Examples are Emerging markets, S&P 500, Large Cap etc.
Lipper Benchmark/Lipper Index
Lipper has a series of benchmarks or indexes to track mutual funds based on their classification. For example there is a Lipper benchmark to track mutual funds that track S&P 500 called Lipper S&P 500 Fund IX, there is a Lipper benchmark to track emerging market mutual funds called Lipper Emerg Mkt Fd IX and so on.
There are over 160 of these indexes which track the total return performance of the largest funds within Lipper categories.
So what’s the difference between a Lipper Classification and a Lipper Benchmark? Lipper Benchmarks are applied only to active mutual funds whereas a Lipper Classification can be applied to passive ETFs as well as active mutual funds.
You may find some funds being touted as a Lipper Leader. This is an exclusive club in the mutual funds’ (& ETFs’) worlds. To be a Lipper Leader, a fund has to be among the top 20% of its peers when ranked against a specific metric – Total Return, Consistent Return, Capital Preservation, Expense and Tax Efficiency (US only ). Each of these categories is given a separate ranking – 5 being the highest and 1 being the lowest.
In the above example, USAGX, a precious precious metals mutual fund offered by USAA, is a Lipper Leader with a top ranking for both Total Return and Consistent Return and rankings of 1, 3 and 4 for Capital Preservation, Tax Efficiency and Expense respectively.
You can see how this can be useful to align your goals with your assets.
Criticisms And Gaming Lipper Statistics
You could be highly ranked by Lipper and you could’ve beaten your competition, but could still have lagged the market when it comes to returns which, ultimately is what matters to the individual investor.
Lipper Average only tracks active mutual funds. A mutual fund that lagged behind the Lipper Average last year could’ve beaten the Lipper average this year for the same period! How could this be you may ask. Investment companies employ tricks such as merging lagging funds, to renaming them to closing them altogether. All these affect rankings even for past periods.
If a fund family touts that 100% of their funds have beaten the Lipper Average, it could very well mean the lagging funds were closed or merged into better performing funds. It does not necessarily mean that the investment company has extraordinarily talented managers.
Here’s another trick mutual fund companies employ to mislead investors. A mutual fund company would incubate a series of funds with its own money but wouldn’t release details about these funds to the public. Those that beat the Lipper Average are opened to the public and those that didn’t make the cut are quietly closed down. All their funds now beat the Lipper Average!
This is unfortunately, quite legal, if not ethical. Investors fall for this all the time.
As An Investor, How Can Lipper Ratings Help Me?
For one, you could use Lipper Ratings to screen mutual funds that meet multiple criteria, not just whether it beat the market or not.
Goto to Reuters’ Fund & ETF Screener Site
You can screen funds based on all the criteria I’ve explained in this post or you could restrict your screenings to just the Lipper Leaders.
Let me illustrate how useful this tool can be to the individual investor. Here’s a comparison of two ETFs that track the same index and are almost identical.
On the face of it, it looks as though it doesn’t make much difference which ETF I choose. Both are passive ETFs that attempts to track a well known index.
But when I compare Lipper Ratings for these ETFs, here’s what I get:
Vanguard’s VWO is the clear winner here in all categories. You can see how useful this is when comparing mutual funds or ETFs with similar goals.
Lipper Metrics are just a tool to help the investor navigate the ocean of ETFs and mutual funds. Having an understanding of this rating system should go a long way in making the right decision when it comes to investing.
The sample ads accompanying this post are meant for illustrative purposes only. This is not necessarily an endorsement by Money Cone.
Long on VWO. No positions in the other funds mentioned in this post.