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Thursday, September 1, 2022

In 2023, a Fund Watcher Will Combine Two Systems

Reported by Neil Anderson, Managing Editor

Next year, fundsters will find their funds receiving a new kind of rating, with a familiar scale and some new datapoints, from a familiar investment research giant.

Lee Davidson
Morningstar, Inc.
Senior Director, Head of Manager and Quantitative Research
Yesterday, Lee Davidson, head of manager and quantitative research at Morningstar, Inc., revealed plans to combine two of M*'s three main fund rating systems. In the second quarter of 2023, the Morningstar Analyst Rating and the Morningstar Quantitative Rating, both forward-looking, will transform together into the new Morningstar Medalist Rating. (The older, backward-looking Morningstar Rating, i.e. star rating, will not be affected by the changes, the M* confirms via an FAQ.)

The Morningstar Medalist Rating, like both of its predecessors, will be built on five pillars: parent, people, performance, price, and process. And the new rating will, again like its predecessors, use a scale with five ranks: gold, silver, bronze, neutral, and negative. The new rating will also incorporate two new datapoints: % analyst assigned, and % data coverage.

Yet the "Q" symbol (indicating quantitative, i.e. algorithmic input as opposed to human input) will be shifted from the overall fund ratings to the individual pillar ratings, indicating which pillar ratings and analysis are computer-generated and which are written by M*'s human analysts. (The variation between quantitative and qualitative is in the people, process, and parent pillar ratings, as the performance and price ratings are always quantitative. And the M* team notes that about 75 percent of current Morningstar Quantitative Ratings already incorporate one or more qualitative pillars ratings from analysts covering related strategies.)

Historical analyst and quantitative ratings will continue to be available once the new rating system is turned on. The M* team insists that their coverage rates (both the number of strategies coverage and the frequency of that coverage) will not change with the new rating system. (Analyst-assigned pillars will be updated every one to two years, as needed, while quantitative pillars will be updated monthly.) And they predict that no funds' ratings will change (from silver to bronze, for example) as part of the system change.

The M* team predicts that the new Morningstar Medalist Rating will apply to more than 400,000 share classes: eliqible managed investments (excluding certain strategies focused on trading or speculation) include ETFs, model portfolios, traditional open-end mutual funds, and SMAs. The change will be rolled out globally and will affect a host of M* offerings, including: Analyst Research Center, data feeds, Morningstar Advisor Workstation, Morningstar Direct, Morningstar Office, the Morningstar.com website, and more.

The planned rating combination and the launch of the Morningstar Medalist Rating, as scheduled, will come about a dozen years after the launch of the Morningstar Analyst Rating and about five years after the unveiling of the Morningstar Quantitative Rating.

Davidson describes the planned rating update as a way to simplify information presentation to investors.

"This should make it easier for investors to analyze, select, and monitor managed investments amid an ever-expanding sea of choices," Davidson states. (The M* team notes that the number of "managed investment products" available around the world is growing at 11 percent per year.)

"The unified ratings system not only reflects our confidence in the efficacy and quality of the two rating systems, but also, better reflects how the Quantitative Rating and Analyst Rating have been joined at the hip," Davidson states. "We designed the Quantitative Rating to mimic the way manager research analysts assign ratings. Put another way, we can't generate the Quantitative Rating without the analysts' ongoing input." 

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