Advisors weigh in on Wall St. Journal’s Morningstar ratings critique

Advisors


According to a recent article in the Wall Street Journal on research firm Morningstar’s star rating system, many investors and their advisors believe that the number of stars assigned to a mutual fund is a good guide to its future performance. Furthermore, the Journal found that investors put new money into five-star-rated funds in 69 percent of the months they held that rating.

Investors’ confidence in the ratings as indicators of future performance is misplaced, however. According to the article, “of funds awarded a coveted five-star overall rating, only 12 percent did well enough over the next five years to earn a top rating for that period.”

CNBC.com contacted several financial advisors for their reaction to the findings.

“While Morningstar stated it never claimed its star ratings are not preordained to be a ‘predictive measure,’ many investors and advisors alike consciously drift into the realm of utilizing five-star-rated funds like a cat to catnip,” said Jon W. Ulin, certified financial planner and managing principal of Ulin & Co. Wealth Management.

Picking a stock, sector or actively managed mutual fund because it recently outperformed over the past year is a case of hindsight bias and chasing returns, he said.

“Our firm has been utilizing Morningstar as a primary screener for almost two decades, and [we] employ the Morningstar Portfolio snapshot tool in client meetings to illustrate the risks, costs, sector exposure and even global positioning of their entire portfolio, but never discuss the actual ratings on their underlying holdings.”

While Morningstar tools can be to used to quickly screen a mutual fund for benchmarking comparisons, it is acutely more challenging to screen for an investment manager’s process and philosophy, Ulin added.

For her part, Winnie Sun, managing director and founding partner of Sun Group Wealth Partners, said her firm has always taken Morningstar’s ratings “with a grain of salt.”

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“But with all the skepticism toward our industry, we have found that clients believe and take comfort that there is Morningstar,” she added. “To our clients, Morningstar is another reputable rating company out there that they could research and justify their investment choices.”

Still, it’s a matter of transparency, Sun noted, and “Morningstar is going need to provide us more value to justify the fees so many of us pay to use their tools.”

In part because of disappointing results from prior-year five-star funds, Sun’s firm has been using more exchange-traded funds in client portfolios, according to Sun.

The relevancy of Morningstar ratings to clients and advisors seems to have declined significantly in recent years, according to Kevin J. Meehan, CFP, regional president at Wealth Enhancement Group.

“I cannot recall a client referencing their ratings in years,” he said. “My sense is [that] as the use of indexing has accelerated — and with fewer fund companies getting a larger percentage of industry asset flows — even the do-it-yourselfer is not building portfolios the same way they were before.”



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