Funds aim to achieve Lipper Leader status, seeking to outperform the Lipper Average, a benchmark that classifies funds based on their performance. This rating system uses extensive data to rank funds on a 1-to-5 scale, distinguishing the top-performing “Lipper Leaders” from lower-rated options. If you’re uncertain about investing in particular funds or how to interpret Lipper ratings, partnering with a financial advisor can provide valuable guidance and help manage your investment choices.
What Is the Lipper Average?
The Lipper Rating System, created by A. Michael Lipper, is a widely recognized financial rating and analytical tool. It was first introduced by Lipper Analytical Services in 1998, which later became part of Thomson Reuters and ultimately rebranded as Refinitiv in 2018.
Lipper’s system categorizes funds based on a Diversified Equity strategy, assessing similar funds against each other across five performance metrics. Based on these results, the system assigns each investment a rating on the Lipper scale, ranging from 1 (lowest) to 5 (highest).
Funds rated as “Lipper Leaders” receive a score of “5,” placing them in the top 20% of their category. This scale ensures that in every category, the bottom 20% receive a “1,” the next 20% a “2,” and so on, continuing this pattern until the top 20% earn a “5.” The Lipper Average then combines these ratings across all five performance metrics to provide an overall fund assessment.
The Lipper Index
The Lipper rating system compares similarly-situated funds against each other, as determined through a two-step classification system. Based on that comparison, it generates a ranking 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 to compare similarly-situated funds. For example, it will rank funds investing in Chinese firms against other firms investing in the Chinese market. 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
The 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.
According to Refinitiv, the Lipper Leaders rating for Total Return may be a good option for investors focused on historical returns without necessarily considering risk. However, this measure alone may not suit those looking to minimize downside risk. For more conservative investors, combining the Total Return rating with Preservation and/or Consistent Return ratings can help identify options that achieve a balanced approach to 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.
According to Refinitiv, Lipper Leader ratings for Consistent Return evaluate a fund’s historical returns, adjusted for volatility, in comparison to similar funds. These ratings are calculated across all Lipper classifications containing at least five distinct portfolios, encompassing both equity and fixed-income funds, such as large-cap core and general U.S. Treasury categories.
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.
According to Refinitiv, Lipper Leader ratings for Preservation assess a fund’s historical ability to minimize losses compared to other funds within its asset class. These Preservation scores are calculated across three main asset categories: 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 on both the costs of their peers and their rate of return. This is a good fit for investors who want to minimize their total costs.
According to Refinitiv, Lipper Leader ratings for Expense assess how well funds manage expenses compared to peers with similar fee structures. These ratings are calculated across all Lipper categories that include at least five unique portfolios, covering both equity and fixed-income funds (such as large-cap core and general U.S. Treasury funds).
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.
According to Refinitiv, the Lipper Leader ratings for Tax Efficiency measure a fund’s historical ability to delay taxable distributions compared to its peers. These Tax Efficiency scores are calculated across all Lipper categories with at least five unique portfolios, covering both equity and fixed-income funds, including categories such as large-cap core and general U.S. Treasury.
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, which 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’s 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 hasn’t improved. If a bunch of new competitors enter 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 live by when making investing decisions.
Bottom Line
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.
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