Morningstar defends star ratings

Morningstarhas today hit back at a report by asset consulting groupFrank Russellwhich questioned the value of the research house’s model for rating managed funds.

Morningstar responded to the report, released by Frank Russell managing director Alan Schoenheimer, by claiming Frank Russell was ignorant of Morningstar’s star rating process and that the group was yet to offer a viable alternative.

“Frank Russell appears to misunderstand the nature and intention of star ratings models for managed funds. Since Morningstar introduced managed fund star ratings in Australia and New Zealand six years ago, at least seven other fund research houses have followed suit,” Morningstar says.

The Frank Russell report, made public by Schoenheimer at last week’s Financial Planning Association conference (FPA), concluded that Morningstar’s star rating system was not a reliable indicator of future short-term performance.

The report found that $1000 invested in an average five star rated Morningstar fund between June 1998 and June 2000 would have produced $1460 at the end of the two year period. But $1000 invested in a four star fund would have produced $1588, despite the funds’ lower rating.

But Morningstar says its star ratings were never intended to predict the future performance of funds, and questioned Frank Russell’s own research record.

“Schoenheimer’s basic premise is that the mark of a good rating is its ability to predict near-term future performance. No one knows the future,” Morningstar says.

“We need only look at Frank Russell’s…research effort - one output of which is the ANZ Gateway funds. These funds are promoted by ANZ as being made possible through an alliance with Frank Russell, which ‘leaves no stone unturned, researching and reviewing some 2,000 fund managers... to find the cream of the crop’,” Morningstar says.

“Of the nine ANZ Gateway funds on Morningstar's infobase, none have provided better than average rolling quarterly returns compared to their peers over their two and a half year lives.”

Morningstar says similar attempts were made to discredit its star ratings system when it was first introduced in the US 15 years ago, but that the system had now been widely accepted.

Morningstar confirmed yesterday that it would not push ahead with legal action against Frank Russell over the report, despite threats of litigation by former Morningstar chief executive Graham Rich.

Rich, who was dismissed by the Morningstar board last weekend, had described the Frank Russell report as defamatory and damaging to the Morningstar star ratings model.