The information content of Morningstar's mutual fund ratings: The case for growth funds

Morningstar classifies mutual funds under its coverage into five categories as one to five-star ratings. Five-star funds are expected to outperform the rest on a risk-adjusted return basis. Furthermore when a fund is upgraded from say a four-star rating to five, it is expected to generate a better r...

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Bibliographic Details
Published inAmerican business review Vol. 21; no. 2; p. 1
Main Authors Lashgari, Malek, Wahad, Mahmoud
Format Journal Article
LanguageEnglish
Published West Haven University of New Haven 01.06.2003
Subjects
Bias
Correlation analysis
Expected utility
Growth funds
Mutual funds
Rates of return
Rating services
Ratings & rankings
Scandals
Securities analysis
Standard deviation
Studies
Treasuries
Treasury bills
United States > US
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Summary:Morningstar classifies mutual funds under its coverage into five categories as one to five-star ratings. Five-star funds are expected to outperform the rest on a risk-adjusted return basis. Furthermore when a fund is upgraded from say a four-star rating to five, it is expected to generate a better return. A downgrade in rank from three stars to one is a signal for selling the fund. This paper uses the surprise index of performance for measuring the predictive power of the Morningstar rating system. Monthly returns for all growth funds are taken from Morningstar for the period 1996-1999. Several methodologies for calculation of returns employed by Morningstar are employed. These include monthly returns, three-month returns, twelve-month returns, three-year total returns, five-year total returns, and year to date returns. Consistency in performance is dependent upon the degree to which a high rated fund would beat the low rated ones, and its track record in remaining as a high rated fund. The degree of surprise associated with changes in star ratings is therefore related to their subsequent returns.
ISSN:0743-2348