A First Look at Morningstar’s Analyst Ratings

November 11, 2014

by Robert Huebscher

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Overwhelming academic evidence documents the difficulty in distinguishing skill from luck among actively managed mutual funds. Despite this fact, many vendors have attempted to identify those that will beat their benchmarks and deliver excess risk-adjusted returns. Noteworthy among those vendors is Morningstar, which offers forward-looking “analyst ratings.” We’ve evaluated the predictive ability of the first vintage of those ratings, which were published three years ago.

Our results affirm the academic research; it’s really tough to pick a winning mutual fund.

Morningstar’s methodology is documented here. The analyst rating reflects the “conviction in the fund’s ability to outperform its peer group and/or relevant benchmark on a risk-adjusted basis over the long term.” Morningstar issues five ratings: gold (the highest), silver, bronze, neutral and negative (the lowest).

The first vintage of ratings, encompassing the 339 funds, is shown here and were the basis for our analysis. Our methodology and results are explained below.

The results of our study

Below is a summary of the 338 funds that survived for the three-year period, along with their analyst ratings and percentage distribution of those ratings:

Number of Funds %
Gold

149

44.1%

Silver

106

31.4%

Bronze

47

13.9%

Neutral

30

8.9%

Negative

6

1.8%

TOTAL

338

100.0%

To create a baseline for our analysis, we divided the 338 funds into five groups based on their expense ratios2. These ranged from the 149 funds with the lowest expense ratios to the six funds with the highest expense ratios.

  1. Michael Edesess and Marianne Brunet assisted in the research for this article.
  2. We did not have access to the expense ratios at the beginning of the period, so we used the expense ratios at the end of the period. Since expense ratios do not change dramatically, we believe this did not have a significant impact on our analysis.

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