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A Guide to Lipper Ratings and “Lipper Leaders”

Eric Reed
lipper

Funds want to be Lipper leaders. They want to beat a Lipper Average. But what the heck is it? It’s a way to classify funds based on their performance. A 1-to-5 scale separates Lipper losers from “Lipper Leaders.” Here’s how the Lipper Average works, who uses it, and how it may help your finances.

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 which gets a 5 rating.

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.

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.

Fund Style

The fund style considers the major characteristics of the fund and its holdings. Those factors includes 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

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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 whith 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.

The Bottom Line

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The Lipper rankings measure the performance many of the largest investment funds in the world. Meanwhile, they rate that performance against similarly situated funds. Investors consider the most successful products “Lipper Leaders.” As a result, “Lipper Leader” became a coveted title in finance.

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