Morningstar has hit back at the Wall Street Journal over an article in the newspaper which criticized the Chicago research shop’s star ratings system.
Under the headline The Morningstar Mirage, the Wall Journal Street published a detailed analysis of Morningstar’s star rating system on Wednesday.
The firm’s shares tumbled around 4% when the story was published yesterday. They recovered sharply later in the day and have since regained their losses and are up 1% on where they were before the article was published.
The crux of the piece was that a Morningstar five-star rating is not an indicator of future outperformance, and that many investors do not realize this.
The Journal looked at the performance of thousands of funds going back to 2003. It found that only 12% of those with a five-star rating performed well enough to maintain that status over the next five years, with 10% dropping to one star over that period.
The article cited case studies of advisors selecting funds based on their five-star rating, only to see performance dip in the following years.
The article highlighted that funds with five-star ratings saw increased inflows once they had gained that status.
It also gave examples of asset managers, such as AB advertising a fund as having a five-star rating, after it had lost this rating.
It was not just the star rating that the WSJ article covered. It also looked at the firm’s analyst ratings, suggesting the performance of funds ranked gold, silver and bronze funds were not dramatically different, and questioned whether asset managers could influence the ratings.
Unsurprisingly Morningstar has not taken this criticism lying down.
In the WSJ article Morningstar pointed out that the star ratings were meant to be used as a first-stage screen and not a predictor of future returns. Its chief executive Kunal Kapoor also batted back any implication that its analysts could be influenced by fund groups. ‘We prize our independence,’ he told the Journal.
Morningstar has also issued detailed responses to the article, both from Kapoor and global director of manager research Jeffrey Ptak.
Kapoor said: ‘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.’
He pointed out that the WSJ’s own analysis found that five-star funds outperform four-star funds which outperform three-star funds which outperform two-star funds which beat one-star funds.
‘That’s not a mirage. That’s tilting the odds in investors’ favor,’ he said.
Read his full response here.
Kapoor went on to say that Morningstar has previously acknowledged the limitations of the star ratings and said they must be used alongside other research tools. He also criticized the Journal’s analysis of the Morningstar analysts ratings, arguing that they should not be measured against the star system.
What about alpha?
Ptak too has written as response headlined Setting the Record Straight on Our Fund Ratings. In this he defends both the star rating system and in particular the analyst ratings, highlighting that higher rated funds tended to produce more alpha going forward, but that this was not a measure used by the WSJ.
He concluded by saying: ‘The Journal’s story notwithstanding, the star rating has been a useful starting point for research that tilts the odds of success in investors' favor. The forward-looking analyst rating, while newer, has also exhibited predictive power. Used together, or separately, we think these ratings can improve outcomes and help investors achieve their goals, which is entirely in keeping with our mission as a firm.’
You can read Ptak's article in full here.