Financial advisors know that Morningstar’s star ratings have limited value in forecasting future mutual fund performance, but what about Morningstar’s analyst ratings for funds — the gold, silver, bronze, neutral and negative ratings it assigns to primarily actively managed mutual funds?
Morningstar recently analyzed the global performance of its analyst ratings to gauge their ability to predict the funds’ future risk-adjusted returns and found that those ratings did have some predictive power.
The study tracked the ratings of roughly 2,000 funds (starting with 1,900 funds and ending with almost 2,700), from November 2011 through April 2017, and fund performance from November 2011 through October 2017. About 90% of the funds were actively managed and about half ((47%) were based in the U.S., with the remaining split roughly two-to-one between Europe, Middle East and Africa (34%) and Asia-Pacific (19%). Equity funds dominated, but bond funds and allocation funds were also included.
Morningstar used two approaches in its analysis: a Fama-MacBeth regression to measure the relationship between the rating and performance of related funds and an event study framework to measure the performance of a given rating over different time (event) horizons, ranging from one month to 60 months. It compared the performance of funds against their peer group (asset category) and benchmark (category index). It also compared the risk-adjusted performance of funds with different analyst ratings to the average capital asset pricing model (CAPM) alpha.
Morningstar found that gold-rated equity funds significantly outperformed their silver and bronze fund peers during multiple time periods and the outperformance was greatest over the longest period of time (60 months, or 5 years).