Embracing risk: a new approach to mutual fund ratings
In the world of mutual fund (MF) investment, the traditional assumption that all investors are inherently risk-averse is being challenged by research. The study by Tiantian REN (Xiangtan University), Kristiaan KERSTENS (IÉSEG, UMR 9221), and Saurav KUMAR (Indira Gandhi Institute of Development Research), brings a fresh perspective by proposing to incorporate “risk-loving” preferences into the ratings of mutual funds. The aim of their work is to contribute to new tools for evaluating and selecting funds, catering to a broader spectrum of investor preferences.
10/16/2025
3 min
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The shift in perspective
Mutual funds comprise a pool or portfolio of money from different investors that are then invested in different stocks, bonds or other instruments. This pool is managed by professionals who allocate the fund’s investments with the goal of producing gains and income for the investors. Agencies that rate mutual funds play a central role in the investment industry by providing independent evaluations of mutual funds. Their primary role is to help investors make informed decisions by offering detailed analyses and ratings based on various factors.
Modern portfolio theory, pioneered by Nobel prize winner Harry Markowitz in 1952, established that portfolio performance should balance returns and risk, assuming investors are risk-averse (RA). However, recent empirical evidence and theoretical developments suggest that some investors exhibit risk-loving (RL) preferences, favoring both high returns and high risk. Furthermore, RA and RL preferences can also be applied to higher moments like skewness and kurtosis. The new study aims to address this gap by proposing new methods that integrate both preferences into mutual fund ratings.
They developed a mathematical model that can handle either risk-averse or risk-loving preferences within a similar framework, which makes it an interesting tool for testing the performance of mutual funds. Under RA, the model seeks for improvements in return and skewness and reductions in variance and kurtosis. Under RL, the model seeks for improvements in return and skewness and also for improvements in variance and kurtosis.
To test the effectiveness of the proposed methods, the researchers tested the methodology on historical data and using a long-term (buy and hold) investment strategy. This comprised 750 French mutual funds with at least ten years of historical prices spanning from February 2011 to August 2021.
Their results found that their methodology had a superior investment performance compared to traditional frontier-based and financial ratings.
“This finding is significant as it suggests that incorporating risk-loving preferences into ratings can lead to better investment outcomes, potentially encouraging more investors to adopt risk-loving behavior because it is in their interest”, explains Professor KERSTENS
Implications for investors and Fund Managers
The study’s findings therefore have applications for both investors and mutual fund managers.
For investors, especially those with risk-loving preferences, these new rating methods provide a more tailored path for evaluating and selecting mutual funds. This could lead to more informed investment decisions and potentially higher returns.
For mutual fund managers, understanding and incorporating risk-loving preferences into their fund offerings and marketing strategies could attract a broader investor base. The performance of funds rated with risk-loving preferences suggests that there is a significant market for funds that cater to risk-loving investors.
Conclusion
By integrating risk-loving preferences into nonparametric frontier-based methods, the study offers a new approach to mutual fund evaluation that caters to a broader range of investor preferences.
This study not only challenges the conventional assumptions of modern portfolio theory but also provides practical tools to navigate the complexities of mutual fund investment.
Find out more in their research article which is available here:
*“Risk-aversion versus risk-loving preferences in nonparametric frontier-based fund ratings: A buy-and-hold backtesting strategy” Tiantian Ren, Kristiaan Kerstens , Saurav Kumar (European Journal of Operational Research, 2024),
