When selecting mutual funds to use in our client’s accounts we use various quantitative and qualitative factors to evaluate if we believe a fund can add value. Morningstar is the most widely used source of mutual fund data and analysis, so we rely on their data for a significant portion of our research. One thing we have learned over the years, however, is to take their star ratings with a grain of salt. This is because the star ratings are really a measure of past performance and are not an indicator of what the future will hold.
“Advisor Perspectives” recently reviewed the predictive ability of the star rating system over a full market cycle and the results of their study were similar to our experiences. In a recent letter published by Robert Huebscher, he states, “We concur that the ratings are not an effective forward-looking measure, but that is not how they are used in the industry. By calling this calculation a rating, Morningstar imparts at least the implicit endorsement of higher- rated funds and an expectation that their relative performance advantage will endure.”
Read the full article here and learn more about fund performance over a full market cycle.