Morningstar's New Star-Rating System: Advances and Innovations

Reichenstein, William
March 2004
Journal of Financial Planning;Mar2004, Vol. 17 Issue 3, p40
Academic Journal
This article illustrates the style bias in the old star-rating system, and introduces the new star-rating system from Morningstar. In July 2002, Morningstar unveiled its new star-rating system. Conceptually, it is easy to summarize the change in the system. The old system compared the historic risk and returns from a mutual fund with the risk and returns of a broad group of funds. The new system tries to compare a mutual fund with a smaller group of similar-style funds. For instance, the old system compared the risk and returns from a domestic large-capitalization growth stock fund with the risk and returns of all domestic funds, while the new system compares its risk and returns with the risk and returns of all domestic large-capitalization growth funds. The old star-rating system compared mutual funds within four broad asset classes: domestic stock funds, international stock funds, taxable bond funds and tax-exempt bond funds. The old system's domestic stock fund category included sector funds, convertible bond funds, hybrid funds that invest in stocks and bonds, as well as diversified stock funds. To highlight the problem with the old system, look at the distributions of star ratings across the two periods for large-growth funds and small-value funds. INSET: Executive Summary.


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