A Glimpse into Morningstar, Straight from the Horse's Mouth

by Katie Bird




Shannon Zimmerman

To many managers, Morningstar may seem like a nebulous entity destined to taunt those who haven’t yet attained a 5-star ranking. Surely you have pondered the methods behind the madness, perhaps muttered “where did they get that from?” at your computer screen.

At the SunStar Strategic Entrepreneurs’ Roundtable, Shannon Zimmerman, an Associate Director of Mutual Fund Analysis at Morningstar, provided a peek into the man behind the curtain, explaining how star rankings are achieved. He also revealed a new qualitative, forward looking grading system soon to be released.

Shannon began by explaining that Morningstar’s priority is to help investors make better decisions, since, “investors tend to gravitate towards good funds, but don’t necessarily put them together to build a good portfolio.” Aside from reminding investors to pay attention to the actual names of funds as indicators of what they do, Shannon noted that not every fund with a lower star ranking deserves it. Yes, you read that correctly. Because the star ranking is a backwards-looking achievement test, it may not take into consideration recently improved performance. If you are lucky enough to have a Morningstar analyst covering your fund, you’ll want to make sure the analyst precisely understands your strategy and process so there is no misconception. The analyst’s report is subjective in nature and may influence an investor’s decision.

But what is this about a new grading system? Starting in November, Morningstar will begin analyzing funds qualitatively as well – Shannon called it an “aptitude” measure. This forward-looking analysis will grade a fund based on what the analyst believes it is likely to accomplish. Rather than stars, funds will be branded with gold, silver or bronze status. Gold signifies the analyst has confidence that the fund will perform well, outperforming its category average in the future. Silver and Bronze will do well, too. (There will also be a neutral and negative grade). Starting in November 2011, 150 funds will be graded. The new reports, available to Morningstar subscribers, will also provide expanded data coverage. This comprehensive investor-focused system will be based on five core pillars:

1. Performance: Why does the fund behave a certain way in particular markets? Did it perform as expected? Is it consistent?

2. People: How talented are the fund managers? Are they invested in their own product? Are they aligned with shareholders? How talented are the analysts?

3. Portfolio: A glimpse into historical performance, fund literature, reports and prospectus. Interviews with managers are conducted to see if they are indeed following their stated strategy. Is the strategy consistent? Any signs of strategic drift?

4. Parent: What priorities prevail at the parent firm? Stewardship or salesmanship? Trendy new products just for the sake of gathering assets?

5. Price: Is the fund a good value proposition compared to similar funds sold through similar channels? The fund fee level is scored and the distribution channel in the mix is examined.

Not currently covered by Morningstar? Shannon also recommended how to get your fund on their radar. There is a six point list that could determine if your fund may be considered to be covered. Reader interest is key. He also suggested you reach out and start a dialogue with Morningstar about why your fund should be covered. Do you have a novel strategy? Are you a boutique shop that deserves attention? Or maybe you just accomplish great execution of a plain vanilla strategy. With 100 analysts worldwide and 4,000 funds currently covered, Shannon drove home the point that Morningstar’s mission is to help investors make better decisions through their opinions and products. There’s room for funds to benefit as well, because, as Shannon said, “if investors win, we all win.”