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Morningstar Rating™ Methodology

Morningstar.com.au  |  26 Jul 2022Text size  Decrease  Increase  |  
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Key Benefits

  • The Morningstar Rating is highly-proficient at assessing a fund manager’s ability to provide added value for investors.
  • Separation of quantitative research (Morningstar Rating) from qualitative research (Morningstar Analyst Rating) reduces complexity and introduces greater transparency to fund assessment.
  • The Morningstar Analyst Rating provides a clear, actionable distillation of fund analysts’ views about an investment strategy.

Background

Morningstar has been publishing star ratings for managed funds in Australia since 1999. Using an easily-identifiable scale from one to five stars,

Morningstar Ratings™ have helped investors and their advisers make more fully-informed decisions about fund managers and their funds, and build and manage better investment portfolios.

Morningstar Ratings for Australian funds are based on a risk-adjusted return quantitative measure, in line with Morningstar’s global ratings methodology. Morningstar’s qualitative research is separate from the star ratings, and incorporated exclusively in the Morningstar Analyst Rating™. Morningstar Ratings are calculated within fundamentally-based fund categories, enabling more robust peer comparisons.

What It Means for You

The key benefit is that this model is highly-proficient at assessing a fund manager’s ability to provide added value for investors. The Morningstar Rating is a pure measure of a fund’s delivery of risk-adjusted returns to investors over the last three, five, and 10 years.

While Morningstar Ratings are solely quantitative measures, our commitment to forward-looking qualitative research remains, as we believe this is critical to helping investors and advisers make informed decisions about fund managers’ capabilities.

The separation of qualitative research—in the form of the Morningstar Analyst Rating—from quantitative research—the Morningstar Rating—reduces complexity, and introduces greater transparency into the intellectual property Morningstar provides for assessing past performance and future prospects. This also increases the universe of funds with Morningstar Ratings, giving greater numbers of investors convenient snapshots of their funds’ track records.

Qualitative Research

The Morningstar Analyst Rating—from ‘Gold’ to ‘Negative’—provides a clear and actionable distillation of our fund analysts’ views about an investment strategy.

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The accompanying report and commentaries focus on key issues and risks, while extensive, regularly-updated holdings, valuation multiples, and performance data offer meaningful insights into current and future performance drivers and outcomes. Readers will understand how a fund manager’s philosophy and process translate into security selection, and whether or not the fund manager is staying true to label.

Quantitative Research

Morningstar Ratings™ are based on a fund’s Morningstar Risk-Adjusted Return (‘MRAR’) measure, the foundation of our global quantitative research since 2002.

MRAR is motivated by ‘expected utility’ theory, whereby an investor ranks alternative portfolios using the mathematical expectation of a function (called the ‘utility’ function) of the end value of each portfolio.

With this basis in expected utility theory, investors are firstly, more concerned about a possible poor outcome than an unexpectedly good outcome; and secondly, willing to give up some portion of their expected return in exchange for greater certainty of return.

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Key Benefits

  • The 50:30:20 10-/five-/three- year Morningstar Risk-Adjusted Return measure rewards consistent good performance over an extended timeframe, and is less subject to short-term performance variations.
  • Fundamental, holdings-based Morningstar Categories enable more robust peer comparisons, and help investors and advisers select and combine funds in ways more likely to translate into true portfolio diversification.

Morningstar Rating

So how does it work? Morningstar calculates each fund’s three-, five-, and 10-year MRAR measures, compared with the risk-free rate as measured by the Australian 90-Day Bank Bill Accepted Rate, provided there are enough monthly returns for these periods (36, 60, and 120 month-ends, respectively).

A fund’s overall Morningstar Rating is a 50:30:20 combination of 10-, five- and three-year Morningstar Ratings, drawn from the MRAR measures for these periods. When a fund does not have a 10-year track record but does have enough history for a five-year rating, we apply a 60:40 split on the five- and three- year Morningstar Ratings. For a fund with only three years worth of history, the overall Morningstar Rating is based entirely on the three-year Rating. These mixes reward consistent good performance over an extended timeframe, and are less subject to short-term variations in fund performance.

Morningstar Categories

A fund’s Morningstar Rating is also relative to the MRAR measures of other funds in the same peer group. This makes it even more important that peer groups are constructed appropriately.

Morningstar Categories are therefore built to create well-defined groups, in which constituent funds can be considered direct alternatives. These Morningstar Categories are based on our global Style Box model, which classifies funds according to the market-cap and investment style of the securities in which funds invest.

Grouping similar-style funds together in discrete Morningstar Categories ensures investment styles are treated equally, and helps investors and advisers select and combine funds in ways more likely to translate into true portfolio diversification.

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© 2022 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'regulated financial advice' under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information, refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Morningstar’s full research reports are the source of any Morningstar Ratings and are available from Morningstar or your adviser. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

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