The Morningstar Analyst Rating is a qualitative, forward-looking rating that seeks to gives an indicator of how an investor might expect a fund to perform in the future. Gold, Silver and Bronze are the positive ratings, followed by Neutral and Negative.
To arrive at that rating, the analysts look at how the fund aligns around these 5 elements: Process, People, Performance, Price, Parent.
Chris Traulsen, Head of Research for Morningstar, explained the relevance and implication of the Gold rating to senior editor Emma Wall.
Gold is the highest conviction rating.
Those are the managers we have the most belief can outperform in the future. Silver is next. Bronze is next and below that we don't have conviction and we think they will actually underperform in the way of Negative, for example, or Neutral.
When our analysts rate funds what they are looking for is managers they think on a going-forward basis can deliver sustainable, repeatable outperformance for investors. That's very different from looking backwards at what they have done in the past.
A Gold rating doesn't necessarily translate into a “buy”.
The analyst is not making an asset class call. So, a Gold-rated fund will be rated Gold because we think the manager can deliver within the context of their asset class in a specific category or sector within that asset class. So, just because we rate a small cap fund Gold, it by no-means means we think it's a good time to buy a small cap fund, for example.
All Gold funds are not the same.
I think the other thing people need to pay attention to is that different Gold-rated funds even within the same category or asset class might have very different characteristics and the same with any of our positive ratings. One may have a technology heavy portfolio, the other a value tilt.
Do the homework to see if that Gold fund fits in your portfolio.
All we are saying is that within that space, that manager is fantastic at doing what he does. It's up to the private investor or their advisor, to make those asset allocation decisions.
Consider asset allocation and conviction in an asset class or sector before making an investment decision. Asset allocation is a huge part of what will determine your future returns, fund selection comes next.
So, what you don't want to do is, say, “I'll have eight of the Golds that Morningstar rates and just stick them together”, because you'll end up with results that are likely to be disappointing. Blending is everything. Just because something has a Gold rating doesn't mean you should put 30% of your portfolio in it. It depends on each investor's situation.
We do give general guidelines for what we think an appropriate role is in a portfolio would be. It could be anything from core to supporting to sort of a niche or a fringe player within a portfolio. Most sector funds, for example, would show up as niche or fringe players, somethings that's highly volatile might show up that way.
But when you combine different asset classes they take on different characteristics. So it is all about building the portfolio, understanding what the correlations are between the different asset classes you have in there and paying attention to that as you weight the funds within the portfolio.
The research methodology
Morningstar evaluates funds based on five key pillars which its analysts believe lead to funds that are more likely to outperform over the long term on a risk-adjusted basis. Analysts assign a rating of Positive, Neutral, or Negative to each pillar.
- Process: What is the fund's strategy and does management have a competitive advantage enabling it to execute the process well and consistently over time?
- Performance: Is the fund's performance pattern logical given its process? Has the fund earned its keep with strong risk-adjusted returns over relevant time periods?
- People: What is Morningstar's assessment of the manager's talent, tenure, and resources?
- Parent: What priorities prevail at the firm? Stewardship or salesmanship?
- Price: Is the fund a good value proposition compared with similar funds sold through similar channels?
Analyst rating scale
- Gold: Best-of-breed fund that distinguishes itself across the five pillars and has garnered the analysts' highest level of conviction.
- Silver: Fund with advantages that outweigh the disadvantages across the five pillars and with sufficient level of analyst conviction to warrant a positive rating.
- Bronze: Fund with notable advantages across several, but perhaps not all, of the five pillars—strengths that give the analysts a high level of conviction.
- Neutral: Fund that isn't likely to deliver standout returns but also isn't likely to significantly underperform, according to the analysts.
- Negative: Fund that has at least one flaw likely to significantly hamper future performance and that is considered by analysts an inferior offering to its peers.
