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).
That was not the case for fixed income funds, where silver-rated funds were the best performers among their peers over 36 months and negatively rated funds were the best performers for 12 and 60 months.
“Fixed income ratings are not as predictive as we would have wanted,” said Jeffrey Ptak, global director, manager research at Morningstar Research Services. “Keep in mind that the study ran from November 2011 through October 2017, which was a fairly pro-risk environment, better for credit risk and extended duration and stocks versus bonds.” Bond fund managers who manage their funds more prudentially “haven’t kept up,” said Ptak.
The performance of asset allocation funds were mixed in terms of the ratings. Gold-rated funds outperformed their peers over the 12-month and 36-month periods, but silver-rated funds performed slightly better than gold funds over the 60-month period.
Analysts ratings have done “a pretty good job but they could do better,” said Ptak, adding that Morningstar would like to see more separation between ratings rungs.
“Gold-rated funds were the standouts of the study … [and] risk-adjusted rating predictiveness improved over longer time periods,” concluded Ptak.
— Check out 20 Best ETFs From 5 Categories: Morningstar, 2017 on ThinkAdvisor.