A 5-star rating might not be enough to instill confidence in mutual fund investors. That’s unless a fund is also able to dazzle with “gold’’ credentials under a ratings system Morningstar is launching.
The Analyst Ratings debuting Tuesday will supplement Morningstar’s well-known performance-based star system. The new ratings will run from gold, silver, and bronze down to neutral and negative. The aim is to give investors a snapshot of a fund’s prospects, rather than its record.
That subjective approach will inevitably lead to occasional bad calls. But Morningstar hopes the new ratings will prove more useful in predicting future performance than its 1- to 5-star system. Both are designed to help investors and their financial advisers narrow the list of potentially worthy funds among the more than 7,000 to choose from.
Funds are awarded stars based on past returns, and the degree of investment risk taken to achieve those results. Morningstar has long acknowledged those measures aren’t necessarily helpful, and many professionals dislike the star system.
“It’s like using a rearview mirror to drive,’’ says Geoff Bobroff of Bobroff Consulting.
Because of that weakness, Bobroff and others say the industry’s new seal of approval for assessing a fund could become gold credentials as well as five stars. One or the other may not be enough.
And a fund company may be reluctant to tout a 4- or 5-star fund unless it also has a halo of gold.
“ ‘Rated bronze by Morningstar’ just doesn’t have much of a ring,’’ says Adrian Day, of Adrian Day Asset Management.
Morningstar isn’t the only company ranking funds - others include Lipper, Standard & Poor’s, Zack’s Investment Research, and U.S. News & World Report. But Morningstar’s are the most influential.
Here’s more of what you can expect from Morningstar’s new analyst ratings:
■When they’ll appear: Morningstar will begin the gradual roll-out by publishing ratings on about 300 funds, focusing on the biggest. Expect to see smaller funds that are noteworthy. By the end of next year, Morningstar plans to have issued analyst ratings on about 1,500 funds.
■How to find ratings: Visit Morningstar’s website and plug in a fund ticker or name.
■How the ratings fit in: Star ratings won’t go away, but the analyst ratings will replace Morningstar’s “Analyst Picks’’ and “Pans.’’ Those are funds that Morningstar analysts consider top choices, or ones to avoid. Less than 3 percent of funds are designated as picks.
There’s no target for how many funds will earn gold. “We’re not managing to a bell curve, where we’re going to force 15 percent into negative ratings, or 5 percent into gold,’’ says Karen Dolan, Morningstar’s director of fund analysis. “Each fund will be assessed on its merits.’’