- Let’s examine how the rating system got its start.
- Identify its current shortcomings.
- Show you what we believe is a better way forward for your investment portfolio.
Evolution of the Morningstar Rating System
- Bases risk scores on perceived investor preferences
- Rewards consistent long-term performance
- Penalizes downside volatility
- Accounts for the effects of sales charges and redemption fees
- Rates funds over a three, five, and ten year time frames
- Weighs each of the above ratings against the track record of the fund and the consistency of its investment style to determine the overall star rating. If a fund changes category, its risk-adjusted return rating prior to the category change is given less weight.
Morningstar Star Rating System Shortcomings
Morningstar Category Definitions
- Funds are grouped by the investment styles or market exposures that govern their portfolios. In general, a single index benchmark should provide a relevant basis for comparison for all funds within a given category.
- In general, funds within a category are considered adequate substitutes for one another within the context of a larger portfolio.
- A fund’s category placement is based on three years of portfolio statistics and supplemented by returns-based style analysis, fund documents, and qualitative analysis.
Source: Morningstar 20171231
- Snow Capital (SNOIX): 32%
- Transamerica (MVTIX): 78%
- Difference: 46%
Varying Definitions of Risk
Purely Quantitative and Backward-Looking Approach
What Investors Should Do Instead
Professional money managers do not rely on star ratings to construct portfolios. They use research, objective processes, attention to your individual risk tolerance and situational needs.
Potomac Fund Management was founded in 1987 as a firm that specializes in fund research and allocation. Decades later, we continue to refine and improve our fund selection process.
Selecting the mix of funds appropriate to each client’s objectives and risk tolerance is part art, part science. Potomac utilizes institutional-style analytics to filter through the vast universe of available funds.
If you’d like to have an experienced financial advisor, who will put your best interests first, take a look at your current retirement plan to see how well your current investments support your goals for the future, click here.