Advisor Perspectives recently completed a study on the usefulness of Morningstar ratings over the course of a full market cycle. The question at hand is basically whether the Morningstar star ratings are useful in predicting future performance. The study’s finding was unambiguous:
Our analysis found that Morningstar’s ratings lost virtually all of their predictive ability when measured over a full market cycle.
In other words, despite the retail investor’s desire to use the star ratings to help select mutual funds—not to mention the fund companies’ desire to use the rating in advertising—they don’t help. You could select funds with a coin flip and it would be just as helpful. (The article includes enough data to make your head spin.)
I suppose this is good news and bad news. The bad news is that there is no shortcut in due diligence. You need to spend time understanding the investment strategy and the reasons behind the performance, whatever it is. The good news is that there is no shortcut in due diligence. Clients can’t simply look at a star rating and reliably predict future performance. They are going to need the help of skilled advisors who are willing to dig in and do the work.
Bottom line: Ignore the star rating and spend your time understanding the investment strategy.
