New fund rating system coming from Morningstar

In an effort to improve its fund ratings for investors, research giant Morningstar Inc. announced on Monday it is overhauling the methodology that underpins its investment fund rating system later this year.

Among other things, funds’ fees will play a bigger part in the new rating methodology. For instance, the firm said the new methodology will deduct funds’ expenses from their analysts’ estimates of how much value they can add before fees.

“This approach has the benefit of evaluating costs relative to what a fund can deliver before fees, yielding a sense of what value investors will net after fees are taken into account, which is what ultimately matters,” it said.

Also, the firm’s “gold, silver and bronze” medals will be tougher to earn for actively managed funds. Under the updated methodology, these medals will be restricted to active strategies that beat both their benchmark and peer group average, net of fees and after accounting for risk.

“In the past [analysts] might have awarded these ratings to active strategies that could beat their average peer or an index, but not both,” it said.

Additionally, Morningstar said that its analysts will award fewer medals to active strategies “in areas where analysis finds there’s less payoff to active investing.”

The firm plans to start rolling out new ratings based on the updated methodology starting Oct. 31, and said that it will take about a year to reevaluate all of the funds that it covers.

The first batch of new ratings will likely include hundreds of funds across a range of geographic regions and asset classes, it noted, but the specific funds to be covered in the first tranche have yet to be determined.

Revised quantitative ratings, which don’t require analyst reports, will be issued in November, Morningstar said.

“We’ve been encouraged by the way investors have incorporated the analyst ratings and quantitative ratings into the research they conduct. We’re building on that acceptance and making the ratings more effective and useful to investors,” said Jeffrey Ptak, head of global manager research for Morninsgtar, in a release announcing the changes.

Staff

The staff of Advisor.ca have been covering news for financial advisors since 1998.