Morningstar Analyst Rating for Funds
The Morningstar Analyst Rating is the summary expression of our forward-looking, qualitative analysis of a fund. This is unlike our backward-looking, quantitatively-driven Morningstar Rating (often referred to as the “star rating”), which assigns one to five stars based on a fund’s past risk- and load-adjusted returns versus category peers. Morningstar Analyst Ratings are assigned globally on a five point scale, with three positive ratings of Gold, Silver and Bronze, one Neutral rating and one Negative rating. The ratings reflect the level of analyst conviction in funds’ ability to outperform the most relevant benchmark and/or peers on a risk-adjusted basis over the long term. The ratings should be interpreted as follows:
- Gold: Best-of-breed fund that distinguishes itself across the five pillars and has garnered the analysts’ highest level of conviction;
- Silver: Fund with notable advantages across several, but perhaps not all, of the five pillars—strengths that give the analysts a high level of conviction;
- Bronze: Fund with advantages that outweigh any disadvantages across the five pillars, and sufficient level of analyst conviction to warrant a positive rating;
- Neutral: Fund that receives neither a strong positive or negative analyst conviction. In our judgment, it isn’t likely to deliver standout returns, but also isn’t likely to significantly underperform; and
- Negative: Fund that has at least one flaw likely to significantly hamper future performance, and is considered an inferior offering to its peers.
Research Methodology: The Five Pillars
To arrive at a rating, our analysts evaluate five key pillars which our experience has shown us are critical to a fund’s ability to succeed: People, Process, Parent, Performance, and Price. Let’s take a deeper look at each pillar:
The overall quality of a fund’s investment team is a significant key to a fund’s ability to deliver superior performance relative to its benchmark and peers. The team often includes a lead portfolio manager, analysts, and other managers who contribute to the fund. When evaluating this pillar, we think about what advantages the team has over their peers along the lines of expertise, experience, and demonstrated skill. The manager’s track record on other funds managed, team stability and the manager’s alignment of interest are also some of the key factors we consider.
Morningstar analysts are agnostic to a manager’s overall style, meaning that we do not have a particular preference for any investment approach. We look for funds with an investment process that is sensible, clearly defined, and repeatable. In addition, the portfolio should be constructed in a manner that is consistent with the investment process. The manager should be able to articulate his investment goals, the risks inherent in the process, a logical set of buy/sell criteria and have appropriate risk control measures in place.
When you invest for the long haul, you realize just how important the company behind the fund is. The parent company sets the tone for key elements of our evaluation, including capacity management, risk management, recruitment, retention of talent, and incentive pay. In this aspect, we prefer firms that have a culture of stewardship and put investors first, as opposed to those that focus on salesmanship. The former do a good job of aligning manager interests with those of fund owners through investor-friendly incentive programs, and treat fund owners’ capital as if it was their own. The latter might be characterized by concentrating on short-term gains by offering trendy funds to gather assets and charging higher fees.
Past performance is not necessarily predictive of future returns, and hence this factor holds a relatively small weighting in our evaluation process. We focus on the long term performance under the current manager to determine whether he or she has added value. Here, we form expectations of how a fund performs in different market environments given its investment process, and compare these expectations against the fund’s actual historical track record. Performance is assessed relative to the correct benchmark and/or appropriate peer group for the fund; if a custom peer group is required, one will be created.
Costs are a good predictor of future performance. We look at a fund's expenses relative to its peer group and within the context of the relevant market or cross-border region, which aligns with the proprietary fund classification systems used by Morningstar around the world. The assessment is made using annual expense ratios, but in the case of funds with performance fees, expenses are evaluated excluding any performance fees and then the structure of the performance fee is evaluated separately.
We pride ourselves on our research independence. We do not charge fund companies to be rated, nor do fund companies commission us for research or ratings. Rating decisions lie solely in the hands of our analysts. For further details on the Morningstar Analyst Rating methodology, please click here.
The Morningstar Global Fund Report
The Morningstar Analyst Rating is accompanied by the Global Fund Report, which explains the Morningstar analyst’s justification for the fund rating and includes a discussion of the analyst’s views on each of the five key pillars. Our aim is to make our rationale for the Analyst Ratings as transparent as possible.
The ratings, and hence reports, will be subject to review at any time. For example, if a fund has a manager change or is tweaking its strategy, we will update the rating to reflect where the fundamentals have shifted.
Use of Morningstar Analyst Ratings
The purpose of the Analyst Ratings is to help investors make informed investment decisions. That said, we are not aiming to replace an investor’s due diligence. Investors have to decide what suits their needs and risk appetite. Moreover, these ratings reflect our belief about a fund's long-term prospects for risk-adjusted performance relative to its peers or its most relevant benchmark, and are not short-term calls on a fund or an asset class.