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Do Morningstar Ratings predict risk-adjusted equity mutual fund performance ? Category : Mutual Fund Rating Services-Morningstar Star Ratings
| Content Provider | Semantic Scholar |
|---|---|
| Copyright Year | 2019 |
| Abstract | Morningstar Ratings have demonstrated some modest predictive information about performance. However, most individual investors will probably be very surprised about what kind of predictive information the stars provide. The stars have been a mild predictor of inferior performance. However, investors act as if the stars predict superior future performance, yet they may contain no such information. Some individual investors seem to use Morningstar Ratings* as a shorthand selector of superior future mutual fund performance.1 Mutual funds with 4 and 5 star ratings have garnered the vast majority of new fund investment money. (See: Do mutual fund Morningstar Ratings changes influence individual investors?) Furthermore, mutual fund companies promote higher star rated funds heavily, but not lower star rated funds. In fact, often the only performance information that many mutual funds supply in their advertising are 4 or 5 star Morningstar Ratings. (See: How Morningstar Ratings for mutual funds are used as a marketing tool) In their study, “Morningstar Ratings and Mutual Fund Performance,” Professor Christopher Blake of Fordham University and Professor Matthew Morey of Pace University analyzed the predictive powers of the Morningstar Ratings.2 In line with other scientific finance studies of mutual fund performance, Professors Blake and Morey found that mutual funds with low star ratings – particularly 1 star funds – were more likely to continue their below average performance in the future. However, in the midand higher-ranges of fund performance, there was little statistical evidence of any real differences in future performance between funds with 5, 4, and 3 star ratings. Funds rated 3, 4, and 5 stars account for 67.5% or about 2/3 of all funds. Differences in future performance between them were trivial. Professors Blake and Morey used Morningstar’s data for 1992 to 1997 and focused most of their analysis on “seasoned” domestic equity funds that had at least 10 years of return information for the study period. They also used all star rated funds in 1993 for certain comparisons. Professors Blake and Morey were careful to ensure that they included all mutual funds in their analysis. They tracked down and determined what had happened to any fund that had gone out of business or was merged into another fund, during the study period. By doing this, they ensured that the data did not suffer from “survivorship bias.” Survivorship bias can significantly distort the conclusions of investment return studies, if it is not accounted for properly. They also made appropriate load adjustments to returns, since Morningstar makes adjustments that allow it to combine loaded and no-load funds, when it calculates the star ratings. About half of the funds in the 1993 sample had front-end loads. Note that sales loads tend to lead to suboptimal fund performance. (See: Avoid mutual funds with sales commissions and 12b-1 fees) Professors Blake and Morey compared the predictive abilities of the star ratings with four performance predictors that are commonly used in the scientific investment literature. These alternate predictors were: ->average monthly historical returns, which they termed a “naive predictor” ->the Sharpe Ratio ->the Jensen single index alpha ->a four-index alpha, which was composed of a) the market, b) a bond index, c) small versus large capitalization, and d) growth versus value. For the 1992 to 1997 “seasoned” |
| File Format | PDF HTM / HTML |
| Alternate Webpage(s) | http://www.theskilledinvestor.com/smartsection+makepdf.itemid+54.htm |
| Language | English |
| Access Restriction | Open |
| Content Type | Text |
| Resource Type | Article |
