You may have read this morning’s Wall Street Journal article by Kirsten Grind, Sarah Krouse, and Tom McGinty.
We strongly disagree with the conclusions it reached about the efficacy of our ratings. We have responded to the Journal to request corrections to numerous points that mischaracterize our business. Nevertheless, we can understand why such criticisms could raise questions. For that reason, I’ll provide some background on the Journal’s examination of Morningstar and respond to the article’s criticisms.
Before I begin, I will point out that the Journal’s own analysis found that 5-star funds outperform 4-star funds which outperform 3-star funds which outperform 2-star funds which beat 1-star funds. That’s not a mirage. That’s tilting the odds in investors’ favor.
Background
The Journal began its examination of Morningstar in 2016. In conducting research, reporters spoke numerous times to senior Morningstar leaders, including Joe and I. We placed no limits on the Journal’sreporters, who delved into many different aspects of our business and had free reign to ask questions. In addition, we also assisted the Journal’s efforts in conducting an in-depth study of our ratings systems. Led by Jeff Ptak, analysts on our research and data teams compiled data that the Journal’s researchers used in testing the efficacy of the star rating and Analyst Rating. Senior research leaders also worked extensively with reporters to help them interpret our data and their research findings. Throughout this process, we have sought to be as transparent and forthcoming as possible. Our entire business is built on bringing transparency to investing, and we welcomed the opportunity to share our work with the Journal.
Our Response to the Journal’s Allegations
Morningstar’s Perceived Influence: We don’t apologize for serving as an influential, independent voice for the investor. This doesn’t always sit well with fund companies whose products we’re independently evaluating, but our mission is to help investors. Not fund companies.
- On Investors: Investors trust Morningstar because they find our advice and research valuable in helping them reach their financial goals. We acknowledge that the Morningstar Rating™ for funds (the star rating) can influence demand, but it’s an overstatement to say the ratings alone have such an outsized impact, because the star rating corresponds with general investing attributes that drive investor demand. For example, investors have shown a strong preference for lower-cost funds that are easier to own and likelier to succeed, and our ratings tend to reward funds that possess those same attributes.
- On the Industry: As an independent voice for the investor, we will sometimes hold views or take stands that run counter to fund companies’ interests and imperatives. Our opinions and conclusions are always grounded in rigorous and thorough research, and we maintain a free flow of communication with the fund companies whose products we analyze. We don’t apologize for calling ’em like we see ’em. That is the nature of what we do as independent analysts.
Star Ratings Performance: We’ve long described the star rating as a worthwhile starting point for research that can help investors make good decisions, when combined with other research and tools.
- We recognize and have often acknowledged the limitations of a measure like the star rating that’s based on past performance, but we also believe it can usefully tilt the odds in investors’ favor, when combined with other research and tools.
- We have a long track record of testing the performance and relevance of data points, including our ratings, and transparently sharing the results of those tests with investors. For a recent example, see “The Morningstar Rating for Funds: Analyzing the Performance of the Star Rating Globally.”
- The Journalsees little predictive value in the star rating, but the results show that investors were far likelier to succeed with 4- and 5-star funds over subsequent periods and much more likely to fail with 1- and 2-star funds, on average.
- Our research finds that the star rating points investors toward cheaper funds that are easier to own and likelier to outperform in the future. These are qualities that correspond with investor success.
Analyst Ratings Performance: When we’ve measured the Morningstar Analyst Rating™ based on risk-adjusted future returns, we’ve found it has done an effective job of pointing investors toward high-performing funds.
- We disagree with the Journal’sapproach to analyzing the Analyst Rating. We don’t feel the funds’ subsequent star ratings are the best way to evaluate performance of the Analyst Rating, since star ratings are based on funds’ risk and load-adjusted returns. However, when assigning Analyst Ratings, Morningstar analysts do not take loads into account.
- When we’ve measured the risk-adjusted performance of the Analyst Rating using risk-adjusted measures like “alpha”, we find that highly-rated funds tend to outperform lower-rated funds.
Potential Misuse of Morningstar Ratings: We have a strong commitment to transparency and education about our rating system.
- While we have taken pains to educate investors and their advisors on the best ways to apply the star rating in practice, some still take a short-cut approach.
- The Journalclaims that we sit idly by while investors and advisors misuse the star rating as if it was predictive, but this is false. We have always said the star rating is a starting point for research and therefore shouldn’t be the sole basis for assessing a fund. Despite that, some advisors use it that way, a practice that shortchanges clients, who are denied the benefit of a more thorough research and fund selection process.
- Misuse of data points is hardly limited to the star rating, which is why we routinely examine how data points are being used in practice and whether there are ways we can help investors better succeed with them.
Potential Conflicts of Interest: We are deeply committed to independence, and are not swayed by business relationships, senior leadership meetings, or conference participation.
- With the forthcoming launch of Morningstar mutual funds, it’s worth noting that manager research analysts sit in a separate entity from Morningstar Investment Management, which will be adviser to the Morningstar funds, if approved.
- We don’t have a pay-to-play model and have always kept our research coverage separate from the business side.
Given the perch we occupy in the industry, this is neither the first nor last time when we will be scrutinized. As I’ve said before, that’s why it is always paramount that each of us always act in an ethical and mission-centric fashion. On that score, there should never be any doubt.
Kind regards,
Kunal Kapoor
CEO of Morningstar, Inc.
