Morningstar Updates Fund Ratings

Changes will focus more on how fees affect performance and raise the bar for fund managers to earn a Gold, Silver or Bronze Morningstar Analyst Rating

Jeffrey Ptak 8 July, 2019 | 1:23PM
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Morningstar Analyst Ratings

Later this year, we’ll be enhancing our forward-looking fund rating systems, the Morningstar Analyst Rating for funds. We’ll be changing the way we assign these ratings to managed investments like funds and investment trusts. 

The Analyst Rating is a forward-looking, qualitative rating that our manager research analysts assign. Funds are rated Gold, Silver, Bronze, Neutral or Negative. The Analyst Rating denotes our analysts’ conviction in a fund’s ability to outperform based on fundamental research they conduct.

Key Changes:

More weight on fees: We’ve always emphasised fees in our assessment, but we’re going to put even more weight on them in a few noticeable ways.

First, we’re going to assign Analyst Ratings to fund share classes, taking fee differences into account. Today, our analysts evaluate a single representative share class of a fund and then apply the Analyst Rating they assign to that share class to every other share class of that fund, irrespective of fee differences. Going forward, the analysts will tailor the Analyst Rating to each individual share class, accounting for fee differences. This means costly share classes that bundle advice and sales fees could see ratings downgrades.

Second, we’re going to assess costs relative to how much value a fund can deliver before fees, not versus other funds. Today, when we evaluate a fund’s fees, we do so by comparing its expense ratio with that of other funds in its peer group, assigning it a rank, and then translating that rank into a Price Pillar rating, which we roll up with the other pillar ratings to arrive at the fund’s overall Analyst Rating. In the future, we’ll compare a fund’s costs with the value we estimate it can deliver to investors before fees. This means it won’t suffice to be the cheapest of an expensive lot. What will matter is whether fees are low enough to leave some value for investors.

Higher Bar for Active Strategies

We’ve been selective when recommending active funds in the past, but we’ll be even pickier in the future, as we’ll be applying an even more exacting standard.

For an active fund to earn a Gold, Silver, or Bronze rating, our research must convince us that the fund can beat both a relevant index and peer group average after fees and adjusting for risk. Currently, we might give the nod to active funds that can beat their benchmark or the average fund, but not both. In the future, they’ll have to clear this higher bar.

We’ll also be taking a more structured approach to estimating how much value different types of active strategies can be expected to deliver before fees. Some types of investing have been more hospitable to active funds than others through the years. That track record should inform the expectations we set, which means that we’ll award more Gold, Silver, and Bronze ratings in some Morningstar Categories than others.

Three Pillars - People, Process, and Parent

Our approach to evaluating funds has been comprehensive, but we’re going to refocus the framework so that it revolves around its more predictive elements and is easier to understand and use.

We’ve previously organised our assessment around five pillar: People, Process, Parent, Performance, and Price. Going forward, we’ll assess People, Process, and Parent, which our research has found do the best job of predicting funds’ future performance before fees. In this way, we’ll be forming expectations of what a strategy can deliver to investors before fees in an even more systematic manner.  

This means we’ll absorb the Performance Pillar into the other three pillars, ensuring that any performance analysis takes place as part of a broader assessment of the fund’s process, people, and parent

Key Benefits

We think these changes will make the ratings easier for investors to understand, more relevant to key decisions they make, and more effective in helping improve the outcomes they can achieve.

We’re simplifying the framework we follow, refining the ratings, and more clearly delineating our expectations. We’re refocusing the assessment around its more-predictive elements, People, Process, and Parent. We’re also refining our pillar ratings by moving to a five-point scale – High, Above Average, Average, Below Average, Low – which should make it easier to tie a fund’s pillar ratings to its overall Analyst Rating and compare between funds.

The revised Analyst Rating is designed to be a better road map for investors choosing between active and passive strategies or deciding between different share classes. The updated assessment framework will consider how productive each type of strategy has been to active managers and that will inform the ratings analysts assign. We’re likely to assign more Gold, Silver, and Bronze ratings to strategies in areas where active managers have enjoyed greater success, fewer in areas where they haven’t.

We’re refocusing around our framework’s more-predictive elements, including our fee assessment, providing a clearer road map that should help improve portfolio construction, and tailoring our ratings to individual fund share classes.

What’s Next?

We’ll begin updating Analyst Ratings under this enhanced framework later this year. Specifically, we plan to issue an initial batch of updated Analyst Ratings on October 31, 2019.

After that we’ll gradually update the rest of our coverage universe. We expect it to take around 12 months to complete this process, reflecting the need to re-evaluate each fund and document our findings in the analyst report we publish each time we assign an Analyst Rating.

By contrast, because the Quantitative Rating assigns ratings algorithmically, we’ll update those ratings en masse in November 2019.  


The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Jeffrey Ptak  Head of Manager Research

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