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Upcoming Analyst Rating for Funds Breaks New Ground

But it is decades in the making, writes Morningstar director of fund analysis Karen Dolan.

Karen Dolan, 11/04/2011

In June, Morningstar announced a new initiative marking an important evolution for our mutual fund research: A new global Morningstar Analyst Rating for funds. We're in the final stages of preparation and plan to launch the initial set of ratings and accompanying research later this month.

While the rating system will be new, the foundation supporting it dates back more than 25 years to Morningstar's early days. Our analysts have been producing qualitative written research on funds, now a key feature of Premium Membership, dating back to the late 1980s. In these reports, the analysts have dug in and provided perspective on various funds, sometimes in strong terms. In a sense, the only difference now is that the Morningstar Analyst Rating will place an easily identifiable label on those views.

The same process first led us to create Analyst Picks and Pans in 1999, a precursor to the new rating system. Picks and Pans is a short list of the best and worst funds available, but the effort left unrated a large middle ground of funds we research closely and know well. The Analyst Rating will replace Picks and Pans and will apply to all of the approximately 1,500 funds we actively cover. The Analyst Ratings are a natural next step for the written research and straight talk you've come to expect from us over the years.

Unlike the backward-looking Morningstar Rating for funds (often referred to as the star rating), which assigns 1 to 5 stars based on a fund's past risk- and load-adjusted returns versus category peers, the Analyst Rating is a forward-looking, comprehensive and qualitative look at a fund's competitive advantages or lack thereof. The new scale runs from Gold, Silver, and Bronze on the positive end to Neutral and Negative. Expressed as medals, the top three tiers are reserved for funds our analyst team thinks have sustainable advantages that position them well versus peers and a relevant benchmark on a risk-adjusted basis over the long haul (at least the next five years).

Morningstar's new Analyst Ratings are qualitative, forward-looking visual representations of the analyst team's view of a fund's potential to succeed.

Our research combines qualitative (analyst-driven) and quantitative (numerically based) factors focused on five key pillars: people, process, parent, price, and performance. The ultimate view on the individual pillars and how they come together is driven by the analyst's overall assessment in consultation with an analyst-ratings committee, which is led in the U.S. by Russ Kinnel, our director of fund research and the brains behind our Picks and Pans. The approach serves not as a formula, but as a robust analytical framework ensuring consistency across Morningstar's coverage universe.

I've told you what the rating is. Now I’ll explain what it is not. The Analyst Rating is not a market call; we will not be expressing a view on large-caps versus small-caps or signaling whether it's a good time to own emerging markets, for example. The Rating is not meant to replace investors' due-diligence process; it cannot assess whether a fund is the right fit for a particular portfolio need and risk tolerance. It is intended to supplement investors' and advisors' own work on funds and, along with our written analysis, provide forward-looking perspective into a fund's potential to succeed. It picks up where commonly watched measures of the recent past leave off.

A few additional key features of the Morningstar Analyst Rating include:

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