What it means
Lipper rates funds on a scale of 1 to 5 for several separate qualities, rather than giving each fund one overall score. A score of 5 puts a fund in the top 20% of its peer group on that measure, a 3 puts it in the middle 20%, and a 1 puts it in the bottom 20%.
Funds that earn the 5 rating are called Lipper Leaders for that measure. The common measures are total return, consistent return, preservation, tax efficiency and expense.
Total return looks at overall gains, consistent return rewards steadiness relative to risk, preservation looks at how well a fund protected capital in falling markets, tax efficiency looks at how much of the return is kept after tax, and expense compares the costs. Because the scores are separate, a fund can be a Leader on one measure and an average performer on another.
A low-cost bond fund might score 5 on expense and preservation but a 3 on total return. This lets investors choose according to what matters most to them, such as low tax or low cost.
The ratings compare funds with similar peers and are calculated over several time periods, so they smooth out short-term luck. They are backward-looking, which means a top rating describes what happened, not what will happen.
Finance professionals use the ratings as one input when choosing funds for a pension plan or treasury portfolio. They should be combined with an understanding of the fund's strategy, its risks, the manager's track record and the fees, rather than relied on alone.
A sensible process uses the ratings to narrow a long list and then applies detailed due diligence to the short list.
In practice
Real-world examples.
Example
A pension committee shortlists three equity funds and finds that only one is a Lipper Leader for consistent return. It chooses that fund because the plan values steady results over spectacular ones. The committee records the rating, the date and the period in its minutes so the decision can be reviewed later.
Example
A retired investor looks for a fund with high tax efficiency. She filters for Lipper Leaders on tax efficiency and finds several candidates, then checks their costs and holdings before choosing one. She understands that the rating describes past tax outcomes and cannot promise the same result next year.
Example
A fund company mentions in its marketing that one of its funds is a Lipper Leader for expense. Compliance makes sure the advert names the measure and the time period, since the fund may not be a Leader on other measures. The wording avoids any suggestion that the fund is the best choice for every investor.
Formula
Calculation
Number of Leaders in a peer group = total funds in the group x 20%.
Suppose a peer group has 250 funds. The top 20% hold the rating of 5, so the number of Lipper Leaders on that measure = 250 x 0.20 = 50 funds. The middle 20% also number 50, and the bottom 20% number 50. If a fund ranks 40th out of 250 on total return, it sits in the top 40 / 250 = 16%, so it qualifies for the top rating.Case study
Seen in the real world.
Ashgrove Wealth is an illustrative, fictional advisory firm that built model portfolios for clients. The firm used to select funds on one-year performance alone, and clients were often disappointed when last year's winners fell behind.
The firm changed its process to screen funds using several Lipper measures, requiring a rating of at least 4 on consistent return and preservation and a rating of 3 or better on expense. It then reviewed holdings and manager history for the funds that passed.
Over three years, in this illustrative case, the portfolios showed less variation from year to year, and client complaints fell. The firm learned that the ratings were most useful as a filter for building a shortlist, not as a substitute for judgement. It continues to meet fund managers before adding any fund to a portfolio.
Watch out
Common mistakes.
- Assuming a Lipper Leader is the best fund overall, when the rating applies to a single measure and a fund may rank lower on others.
- Treating a rating as a prediction, when it describes past results.
- Comparing ratings across different categories, when each score is relative to the fund's own peer group.
Questions
People also ask.
What does a rating of 5 mean?
It means the fund is in the top 20% of its peer group on that measure.
How often are ratings updated?
They are refreshed regularly and rely on performance over several periods, such as three, five and ten years.
Is a Lipper Leader the same as a Morningstar five-star fund?
No, they are different systems with different methods, so a fund can score well in one and not in the other.
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