Morningstar announced its plans to transition its forward-looking, analyst-driven Morningstar Qualitative RatingTM scale for funds in Europe and Asia to a new global fund ratings scale applied to the funds Morningstar covers worldwide. The company will also transition to a worldwide, uniform approach for fund research reports. The company plans to launch the new ratings and research reports in Europe and Asia in the fourth quarter.
Morningstar introduced qualitative fund ratings in Europe and Asia in February 2009 and its UK-based OBSR unit has provided analyst ratings since 2002. The new analyst ratings and reports will continue to be based on analysts’ convictions about a fund’s ability to outperform its peer group and/or relevant benchmark on a risk-adjusted basis over the long term.
The new Morningstar Analyst RatingTM for funds will be assigned as one of five ratings—AAA, AA, A, Neutral, or Negative. Analysts arrive at a rating through an evaluation of five key pillars Morningstar believes are crucial to predicting the future success of a fund: People, Process, Parent, Performance, and Price. If a fund receives a positive rating of AAA, AA, or A, it means Morningstar analysts think highly of the fund and expect it to outperform its peer group and/or relevant benchmark on a risk-adjusted basis over a full market cycle of at least five years. The ratings scale is as follows:
• AAA: Best-of-breed fund that distinguishes itself across the five pillars and has garnered the analysts’ highest level of conviction;
• AA: Fund with notable advantages across several, but perhaps not all, of the five pillars—strengths that give the analysts a high level of conviction;
• A: Fund with advantages that outweigh any disadvantages across the five pillars, with sufficient level of analyst conviction to warrant a positive rating;
Neutral: Fund that isn’t likely to deliver standout returns, but also isn’t likely to significantly underperform; and
Negative: Fund with at least one flaw that is likely to significantly hamper future performance, and is considered an inferior offering to its peers.
“Morningstar has been providing independent, analyst-driven fund research for 25 years, but we’ve now codified the various evaluation methods used by our team of more than 90 analysts around the world to create one harmonized global rating system. The rating is designed to supplement the fund due diligence process for investors and advisors and identify funds worth investing in over the long term. It is not designed to be a short-term market call on an asset class. The new rating system better surfaces the work of our global research team and helps investors determine whether Morningstar analysts think a fund is worth considering,” said Don Phillips, president of fund research at Morningstar. “Analysts will assign positive ratings to funds they believe have enduring advantages and expect to outperform over the long term. Unlike many of our competitors, our ratings scale is unique because we’re not only identifying good funds, but mediocre and poor ones as well.”
The Morningstar Analyst RatingTM evaluates funds on five key pillars, considering both numeric as well as analyst-driven factors. This approach notably puts only partial weight on past performance and backward-looking risk measures and does not dismiss funds that have underperformed or have limited track records. It will also be more responsive to significant changes at a fund or parent organization. The five pillars are:
• People: Quality of a fund’s investment team, based on factors including its experience, stability, structure, communication, and alignment of interests with fund shareholders;
• Process: Quality of investment process—in terms of both security selection and portfolio construction—and whether it is sensible, clearly defined, and repeatable. Also judges whether the process is effectively implemented and whether the portfolio is consistent with the stated process;
• Parent: Quality of the parent organization, including capacity and risk management, recruitment and retention of talent, incentive pay, and culture of stewardship;
• Performance: Evaluation of long-term returns, consistency of performance in different market conditions, and performance relative to manager changes and changes in asset size; and
• Price: Evaluation of annual expense ratios, and performance fees if appropriate, within the context of the relevant market or cross-border region.
The new analyst ratings for funds, like the current qualitative ratings they will replace, will be available for free on Morningstar’s individual investor websites in Europe and Asia. Financial advisors will have access to the Analyst Ratings and the in-depth Morningstar Global Fund Research Reports for funds available for sale in their respective market through Morningstar’s advisor software products. The Analyst Ratings and in-depth Global Fund Research Reports for all the funds that Morningstar covers worldwide will be available in Morningstar Direct SM, the company’s web-based global research platform for institutional investors.
Morningstar plans to launch the new Analyst Ratings for European and Asian funds in the fourth quarter, focusing on funds that have garnered the most investor interest and assets. In addition to the largest funds, the analyst team will devote a portion of its coverage universe to smaller funds with distinguishing characteristics. Morningstar has more than 90 fund and ETF analysts worldwide who cover about $9 trillion in assets globally. The company provides data on approximately 140,000 mutual fund share classes.
Morningstar’s current analyst-driven rating scale for funds offered in Australia, New Zealand, and the United Kingdom, including OBSR’s Fund Ratings, will also transition to Morningstar’s new global Analyst Rating for Funds scale in the fourth quarter, and the new Analyst Ratings will be introduced in the United States and Canada in the fourth quarter as well.
“We’ve been providing qualitative fund research to investors in Europe and Asia for more than two years, and the new global ratings scale and harmonized methodology allow us to fully leverage the expertise of our worldwide analyst staff,” said Christopher Traulsen, director of European and Asian fund research for Morningstar. “The move to a common rating system will further emphasise the global depth of our fund research, and ensure a consistent experience for investors who use our research across multiple markets.”
Morningstar does not charge fund groups to be rated, and its decision to rate and report on a specific fund is made solely by the analyst team based on factors such as investor interest and asset size.
Like the current qualitative fund rating in Europe and Asia, the new Morningstar Analyst RatingTM for funds is a qualitative, forward-looking measure based on analyst research, whereas the well-known Morningstar RatingTM for funds, or the “star rating,” is a purely quantitative, backward-looking measure that rates historical performance based on risk- and cost-adjusted returns without any input from Morningstar’s analysts. The new analyst ratings will not replace the star ratings, and the existing star rating methodology will not change. Morningstar considers the new analyst rating to be an “aptitude test” that is intended to supplement the star rating, which is an “achievement test.”
For more information about the Analyst Rating for funds, please visit here.