Looking to give advisors new measures for evaluating funds, Morningstar plans later this year to release a new “forward-looking” rating tool that uses its analysts’ expertise to evaluate the funds’ ability to outperform their benchmarks. Morningstar Analyst Rating, as it’s called, is not intended to replace the firm’s longstanding, and sometimes criticized, “star” rating system, but it will replace the “Analyst Picks and Pans” proprietary list of best- and least-loved funds in each category as selected by Morningstar’s staff of 90 analysts globally.
“It is not designed to be a short-term market call on an asset class,” Morningstar Managing Director Don Phillips says. “Analysts will assign positive ratings to funds they believe have enduring advantages and expect to outperform over the long term. Unlike our competitors, our ratings scale is unique because we’re not only identifying good funds, but mediocre and poor ones as well.”
The ranking will run from the top score of AAA to AA, A, Neutral, and Negative. Morningstar will release 150 to 200 analyst ratings for U.S. funds in the fourth quarter with an eye on covering more than 1,500 U.S. funds over the next year. The criteria used to select the funds rated will be investor interestand asset size.
No changes are planned in the methodology of the “star” rating system, technically known as the Morningstar Rating for funds, the company says. The star system measures historical performance based on risk- and cost-adjusted returns; analyst input is not a part of that measure.
The common view that past performance is an unreliable measure of future results has led some to paint the star system in an unflattering light. In fact, last year Morningstar Director of Research Russel Kinnel wrote a piece comparing expense ratios and the star rating and concluded that expense ratios had an edge over the stars when weighing funds’ prospects. “How often did it pay to heed the star rating? Most of the time, with a few exceptions. How often did the star rating beat expenses as a predictor? Slightly less than half the time, taking into account funds that expired during the time period.”
Morningstar Analyst Rating will look at past performance as well, but it also will take other criteria into account, such as the quality of a fund’s investment team and the fund’s investment process, the condition of the parent organization, and annual expense ratios and performance fees when applicable.