We're focusing on fees

Morningstar's Analyst Ratings now feature alpha in a way that matters most to investors: performance for a fair price

Ian Tam, CFA 8 January, 2020 | 1:19AM
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Ian Tam: Earlier this year, Morningstar revamped our fund ratings methodology to streamline the framework and put a greater emphasis on fees. Our focus still remains unchanged. We still put emphasis on our five pillars, people, process, parent price, and performance. However, in our new framework, the price pillar has become far more explicit. Today. I'll explain this in a bit of detail.

So, here, you'll see an overview of our fund ratings methodology and how it breaks out. To start with, we calculate an aggregate score called the expected gross of fee alpha. As you can see, it's basically a weighted average of our people, process and parent scores, multiplied by something called the semi inter quartile range or the semi IQR. In a nutshell, the semi IQR is a multiplier that is calculated for each fund category to lever up or down the effects of our pillar scores. For example, a fund in the U.S. large cap space will generally have a lower semi IQR since most managers typically tend to return something close to the category average. A fund in something more specialized, like perhaps global small or mid cap equities, might have a wider dispersion of returns, which would result in a higher semi IQR.

We then take this expected gross of fee alpha calculation, and then explicitly subtract the appropriate fees to arrive at the expected net of fee alpha. It is this net of fee alpha that is what drives our fund ratings. You'll see here the distribution of our Gold, Silver, Bronze, Neutral and Negative ratings. The result of all this is actually a much more explicit focus on the price pillar. By subtracting the management expense ratio from the underlying people, process and parent combination, Morningstar is able to clearly rate different share classes of funds, which at the end of the day is what matters most to investors since you're being charged for the share class that you're invested in.

For Morningstar, I'm Ian Tam.

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About Author

Ian Tam, CFA  is Investment Specialist at Morningstar Canada. 


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