Can Morningstar Analyst Ratings Predict Fund Performance?

Abstract

This paper analyzes the Morningstar Inc.s new Analyst Ratings that were introduced in November 2011. The ratings are intended to help investors make long-term investment decisions. According to Morningstar, these ratings reflect the long-term risk-adjusted performance of mutual funds. This paper examines whether the Analyst Ratings can predict future fund performance. We assume that the rated funds would have a similar rating in 2010, since they are not based on short-term performance measures, and using quantile regressions, we find that the Analyst Ratings are significantly positively related to future fund performance, measured by Alpha in 2012, that captures the performance over the past three years, 2010, 2011, and 2012. The Analyst Rating is a synthesis of five individual aspects (pillars) of a fund, namely, People, Parent, Process, Performance, and Price. We also find that funds with a higher People Rating will perform better in the future. Since Morningstar contends that the Analyst Ratings are not based on short-term measures of performance, we test this statement also, and using Ordinary Least Squares model find that these ratings are in fact, significantly positively related to contemporaneous fund performance, using the Sharpe Ratio, as a measure. In spite of the assumptions made in this analysis, we argue that these results are important as this paper is the first to analyze the Analyst Ratings and we present some important findings.