Morningstar Rolls Out New Ratings System

In the past, Morningstar ranked a fund’s price tag vs. those of its peer group. Now, the research group is “simply subtracting a fund’s expenses from our estimate of how much value it can add before fees. If there’s nothing left for investors, then we won’t recommend the fund,” he wrote. 

Though the research group used to give the same rating for all share classes of a fund, it’s moved to tailor ratings to each share class by taking its specific fees into account. “Thus, costlier share classes see lower ratings in some situations,” according to Ptak.  

Active vs. Passive 

To earn Gold, Silver and Bronze ratings, Morningstar researchers must believe “that an active fund can beat its benchmark index after fees, adjusted for risk,” he points out. 

In the past, it might have recommended an active fund that could outperform “its average peer but not a costless index, net of fees and after adjusting for risk,” Ptak said. “Now we won’t recommend an active fund if it can’t clear both a relevant benchmark index and peer group average.”

An Example

Morningstar shared a before-and-after look of one fund, MFS Utilities. This is the fund’s Analyst Ratings and pillar ratings using the old methodology:

Here’s  the new approach, which has two fewer pillar ratings, a different pillar ratings scale and varied Analyst Ratings for the fund’s nine share classes — reflecting the different fees the share classes levy. 

“When we accounted for each share class’ specific fees as part of our analysis, we concluded that these more expensive share classes wouldn’t add value for investors after adjusting for risk. That explains why they received Neutral ratings while the fund’s less costly share classes got Bronze ratings,” Ptak explained.