Morningstar is embroiled in a dispute with two professors at Pace University over the effectiveness of its stewardship grade ratings system. Morningstar developed stewardship grades in order to evaluate the mutual funds it tracks by corporate culture and responsibility, in addition to its performance-based star rating system, believing stewardship has predictive value of future returns.
Aron Gottesman and Matthew Morey, finance professors at Pace University’s Lubin School of Business, released a study, “Mutual Fund Corporate Culture and Performance,” on Wednesday that tested the theory. Gottesman and Morey examined the ability of corporate culture ratings to predict risk-adjusted performance of domestic equity funds from 2005 to 2010.
“We find there is little significant evidence that corporate culture predicts better fund performance,” the researchers write. “Indeed, we find that no individual component of the Morningstar stewardship rating including board quality, fees, manager incentives and regulatory issues is able to consistently predict fund performance.
“Arguably the most important component of the Morningstar stewardship rating is fund corporate culture as it sets the tone for the entire operation of the fund,” they add. “Indeed, the culture of the fund conveys how well employees are treated, how the fund treats its own investors, and how well the fund communicates with its shareholders.”
As the authors note, in the wake of the late-trading and market-timing scandals in 2003, there has been a great deal of interest in the governance of mutual fund companies, the reason Morningstar developed the grades.
Unlike the star ratings, which focus only on past fund performance, the stewardship ratings examine five governance factors of the fund company itself: board quality, corporate culture, fees, manager incentives and regulatory issues. The stewardship ratings essentially allow an investor to determine how well the fund company is taking care of its fiduciary responsibilities, Gottesman and Morey say.
Morningstar reacted strongly to the Gottesman-Morey study in a detailed response, claiming it had “serious flaws.”