The firm’s new framework promises to properly prioritize fees and foster a more refined evaluation of key pillars
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Following a note to clients released last week, independent investment research firm Morningstar has officially announced plans to enhance two of its forward-looking fund ratings systems.
“We've been encouraged by the way investors have incorporated the Analyst Ratings and Quantitative Ratings into the research they conduct,” said Jeffrey Ptak, Morningstar's head of global manager research, in a statement. “We're building on that acceptance and making the ratings more effective and useful to investors.”
The changes, which will begin to take effect on October 31, will be applied to the firm’s Analyst Rating and Quantitative Rating systems for funds. The forward-looking Analyst Rating — which labels funds as Gold, Silver, Bronze, Neutral, or Negative — will follow a different underlying methodology that sets a higher bar for funds to earn ratings above Neutral while doubling down on fees.
“Analysts will limit Medalist ratings—Gold, Silver, and Bronze—to active strategies that can surpass a relevant benchmark and peer group average net of fees and after accounting for risk,” Morningstar said. Fewer Medalist ratings to active strategies in areas where analysis suggests active investing produces less payoff compared to indexing.
The firm currently follows a five-pillar framework that includes People Process, Parent, Performance, and Price. The new framework will have analysts assessing just the first three pillars to estimate the value added by a strategy before fees. Performance and Price will no longer be standalone pillars; analysts’ performance assessments will be incorporated into the three surviving pillars, and price will be expressed differently.
“Currently, a strategy's fee rank within its peer group drives its Price pillar rating, which feeds into the overall Analyst Rating,” the firm said. Under the new methodology, a strategy’s expenses will be deducted from analysts’ estimate of the before-fee value it can add, which will be based in part on people, process, and parent pillar assessments. Aside from creating a sense of the after-fee value investors can expect, the methodology is said to put the fee assessment “on the same plane as the analysts’ research into the other three pillars.”
While the new evaluations will rely on fewer pillars, it will also have a more refined ratings scale. Rather than the current “positive,” “neutral,” and “negative” scoring system, each pillar will be rated on a five-point scale including “high,” “above average,” “average,” “below average,” and “low.”
And unlike the system today where all the share classes of a fund are rated based on the evaluation of a single representative fund share class, the new system will account for fee differences between share classes. That could result in ratings downgrades for share classes that bundle advice and sales fees, the firm said.
Aside from the Analyst Rating, Morningstar is making accompanying updates to its Quantitative Ratings. A companion forward-looking system, the quantitative scale uses machine learning techniques to ascribe ratings to funds not covered by the firm’s analysts.
