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lipperFunds want to be Lipper leaders. They want to beat a Lipper Average, which is a way to classify funds based on their performance. The rating system takes a lot of data to determine where each fund falls, on a 1-to-5 scale that separates Lipper losers from “Lipper Leaders.” If you’re concerned about investing in specific funds or aren’t sure how to apply the Lipper data, consider working with a financial advisor who can make all of your fund investment decisions for you.

Lipper Average Defined

The Lipper Rating System is a financial rating system and analytical data set developed by A. Michael Lipper. Originally published by Lipper Analytical Services in 1998, the system changed hands when Thomson Reuters purchased Lipper Analytical Services. Lipper Analytical became Refinitiv in 2018.

The Lipper Average classifies funds based on what it calls a Diversified Equity strategy. It rates similar funds against each other based on five different metrics of performance. Based on the results this system ranks investments according to their Lipper Average, using a scale from 1 (worst) to 5 (best).

A Lipper Leader is any fund that gets a “5” rating and is classified as being in the top 20% of a category. This means that in every category a fund will be ranked based on the lowest 20% getting a “1”, the next 20% getting a “2” and on until the top 20% receives a “5” as the top of the category. The average is an average of those ratings based on all five metrics.

The Lipper Index

The Lipper rating system compares similarly-situated funds against each other and based on that comparison it generates its ranking system. It determines similarity through a two-step classification system.

1. Market Capitalization

First, the Lipper system determines a fund’s market capitalization. It sorts funds by their weighted assets, ranking them as multi-, large-, mid-, and small-cap. Generally speaking, the Lipper system categorizes a fund’s market capitalization according to a supermajority of its weighted assets.

2. Fund Style

The fund style considers the major characteristics of the fund and its holdings. Those factors include the region, industry, return and index. The Lipper system evaluates style to try and compare similarly-situated funds. For example, it will rank funds investing in Chinese firms against other firms investing in the Chinese market. for example. Also, it ranks funds investing in certain industries against other firms investing in those fields.

Between capitalization and style, the Lipper system classifies a fund. This includes classifications such as Utility Funds, Japanese Funds and Gold-Oriented Funds. Each classification, otherwise known as a Lipper Index, contains 30 of the largest funds that meet the style and capitalization metrics for its class.

How Does Lipper Rate Funds

lipperThe Lipper system only compares funds within the same index. Consequently, this ensures that funds match up against their peers. However, this means that the system might not rate otherwise-comparable funds against each other. For example, two large-cap funds with holdings in different industries won’t be compared against each other.

Each index ranks funds based on four metrics: total return, consistent return, wealth preservation and expense. Tax efficiency also helps rank funds in the United States. Each of these metrics also measures 3-year, 5-year, 10-year and overall performance. As a result, this creates either 12 or 15 rankings per fund. The Lipper system updates these ratings every month.

Total Return

This metric rates funds based on the total amount of money that investors receive. Lipper Leaders in this category have provided the largest gains compared with similarly situated funds.

Per Refinitiv:

Lipper Leaders for Total Return may be the best fit for investors who want the best historical return, without looking at risk. This measure alone may not be suitable for investors who want to avoid downside risk. For more risk-averse investors, Total Return ratings can be used with Preservation and/or Consistent Return ratings to make an appropriate selection that balances the risk and return.

Consistent Return

This metric rates funds based on their consistency. Lipper Leaders in this category have provided the steadiest, best returns when adjusting for risk.

Per Refinitiv:

Lipper Leader ratings for Consistent Return reflect funds’ historic returns, adjusted for volatility, relative to peers. Ratings for Consistent Return are computed for all Lipper classifications with five or more distinct portfolios and span both equity and fixed-income funds (e.g., large-cap core, general U.S. Treasury, etc.).

Wealth Preservation

This metric rates funds based on how well they preserve an investor’s initial capital across various markets and investments. This is the best category for investors looking to minimize their risk.

Per Refinitiv:

Lipper Leader ratings for Preservation reflect funds’ historical loss avoidance relative to other funds within the same asset class. Scores for Preservation are computed from three broad asset classes — equity funds, mixed-equity funds, and fixed-income (bond) funds.

Expense

This metric rates funds based on how well they’re able to keep costs low based both on the costs of their peers and on their rate of return. This is a good fit for investors who want to minimize their total costs.

Per Refinitiv:

Lipper Leader ratings for Expense reflect funds’ expense minimization relative to peers with similar load structures. Ratings for Expense are computed for all Lipper classifications with five or more distinct portfolios and span both equity and fixed-income funds (e.g., large-cap core, general U.S. Treasury, etc.).

Tax Efficiency

This metric rates funds based on how well they’re able to manage an investor’s taxes. In particular, it measures how well a fund manages to postpone taxes over the measurement period. This metric doesn’t account for actual returns, just tax management.

Per Refinitiv:

Lipper Leader ratings for Tax Efficiency reflect funds’ historical success in postponing taxable distributions relative to peers. Scores for Tax Efficiency are computed for all Lipper classifications with five or more distinct portfolios and span both equity and fixed-income funds (e.g., large-cap core, general U.S. Treasury, etc.).

The funds in each index receive scores for each metric in each time period. The bottom 20% of funds receive a “1.” The second quintile receives a “2,” the third a “3,” the fourth a “4.” Meanwhile, the fifth quintile receives a “5.” The top 20% of funds, those ranked “5,” earn the “Lipper Leaders” designation.

Drawbacks to the Lipper Rating System

The Lipper rating system isn’t perfect, and it has its drawbacks that make some investors unwilling to make decisions based off of the ratings. Since mutual funds are ranked in the top 20% of all funds, there is some room for error in actual performance. The 20% threshold makes it easy for large fund managers to introduce new mutual funds and increase their size or in other categories without necessarily earning it.

This means that some funds can be ranked in the top 20% even if the overall score of the fund has not improved at all. If a bunch of new competitors enters the market and they climb from being ranked in the second 20% to the top 20%, then they become a Lipper Leader even if their scores decreased overall.

This certainly makes it an interesting tool to gauge the best funds available, but not a perfect tool to only live by when making investing decisions.

The Bottom Line

lipper

The Lipper rankings measure the performance of many of the largest investment funds in the world against similarly situated funds. Investors consider the most successful products “Lipper Leaders.” As a result, “Lipper Leader” became a coveted title in finance and many investors and brokers look for these funds to invest in so that they can achieve the largest possible returns.

Investment Tips

  • Learn the tricks of the trade, then talk shop with the professionals. Finding the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • The best portfolios, whether personal or professional, depend on proper asset allocation. SmartAsset’s allocation tool can help you decide what to buy, where to invest and how to divide up your money.

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Eric Reed Eric Reed is a freelance journalist who specializes in economics, policy and global issues, with substantial coverage of finance and personal finance. He has contributed to outlets including The Street, CNBC, Glassdoor and Consumer Reports. Eric’s work focuses on the human impact of abstract issues, emphasizing analytical journalism that helps readers more fully understand their world and their money. He has reported from more than a dozen countries, with datelines that include Sao Paolo, Brazil; Phnom Penh, Cambodia; and Athens, Greece. A former attorney, before becoming a journalist Eric worked in securities litigation and white collar criminal defense with a pro bono specialty in human trafficking issues. He graduated from the University of Michigan Law School and can be found any given Saturday in the fall cheering on his Wolverines.
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