Morningstar

What Is Morningstar?

Morningstar is a leading global financial services firm that provides independent investment research to individual and institutional investors. The company specializes in analyzing a wide range of investment vehicles, including mutual funds, exchange-traded funds (ETFs), stocks, and bonds. Operating within the broader field of financial services, Morningstar aims to empower investor success by offering comprehensive data, analytical tools, and objective insights that help individuals and professionals make informed investment decisions. Its offerings are central to understanding market performance and evaluating investment opportunities.

History and Origin

Morningstar was founded in 1984 by Joe Mansueto, who started the company from his Chicago apartment with an initial investment of $80,000. Inspired by the last line of Henry David Thoreau's Walden—"the sun is but a morning star"—Mansueto sought to democratize access to investment information, believing that individual investors should have the same resources as financial professionals. A pivotal moment in Morningstar's history was the debut of its proprietary Morningstar Rating™ for mutual funds in 1985. This star rating system quickly became a widely recognized benchmark for evaluating fund performance and risk. Over the years, Morningstar expanded its offerings beyond mutual funds to include data and analysis on stocks, ETFs, and other securities, launching Morningstar.com in 1997. The firm has grown into a global entity, continually evolving its research methodologies and product suite to serve a diverse client base.

⁴Key Takeaways

• Morningstar is a global financial services firm providing independent investment research and data.
• The company was founded in 1984 by Joe Mansueto to empower individual investors with professional-grade information.
• Its most recognized product is the Morningstar Rating™ (star rating) for funds, which assesses past risk-adjusted performance.
• Morningstar offers a suite of analytical tools, data, and research for various investment vehicles, including mutual funds, ETFs, stocks, and bonds.
• Beyond quantitative ratings, Morningstar also provides qualitative analyst ratings and sustainable investing insights.

Formula and Calculation

While Morningstar as a company doesn't have a singular formula, its well-known Morningstar Rating™ for funds is based on a proprietary risk-adjusted return measure. This measure accounts for a fund's historical performance (over three, five, and ten years) and its associated market volatility. Funds are ranked within their respective Morningstar Categories, with the top 10% receiving five stars, the next 22.5% four stars, the middle 35% three stars, the next 22.5% two stars, and the bottom 10% one star.

The calculation of the Morningstar Risk-Adjusted Return involves deducting a penalty for downside risk from the fund's total return. The penalty is higher for greater volatility, particularly on the downside. The exact methodology is complex and takes into account variations in monthly returns. The final star rating is determined by comparing a fund's calculated risk-adjusted return to those of its peers within the same Morningstar Category.

The generalized concept for risk-adjusted return could be visualized as:

This approach aims to ensure that higher ratings are assigned to funds that have delivered superior returns without taking on excessive risk. The calculation is performed monthly and requires a fund to have at least a three-year operating history to receive a rating.

Interpreting the Morningstar Ratings

Interpreting Morningstar's various ratings, particularly the widely recognized star rating, requires understanding their basis. The star rating is a quantitative, backward-looking measure reflecting a fund's past risk-adjusted performance relative to its peers within the same Morningstar Category. A five-star rating indicates that a fund has outperformed 90% of its peers on a risk-adjusted basis over the rated period, while a one-star rating suggests underperformance. Investors often use these ratings as an initial screening tool to identify funds that have historically demonstrated strong investment performance relative to their risk profile.

Beyond the star rating, Morningstar also provides qualitative Analyst Ratings (Gold, Silver, Bronze, Neutral, Negative), which are forward-looking assessments based on a team of analysts' conviction in a fund's potential future performance. These ratings consider factors like the fund's people, process, and parent company. Furthermore, the Morningstar Sustainability Rating assesses a portfolio's exposure to environmental, social, and governance (ESG) risks and opportunities, providing a "globe" rating to indicate how well the fund's holdings manage these factors compared to their peers.

Hypothetical Example

Consider an investor, Sarah, who is looking to invest in a large-cap growth mutual fund. She uses Morningstar's tools to screen for funds.

1. Initial Screen: Sarah filters for large-cap growth funds with a Morningstar Rating™ of four or five stars over the past five years. This narrows down her options significantly, highlighting funds that have historically delivered strong risk-adjusted return compared to similar funds.
2. Deeper Dive: She then examines the Morningstar Analyst Ratings for the top-rated funds. One fund, "Growth Equity Fund A," has a five-star rating and a "Gold" Analyst Rating. Another, "Innovators Fund B," also has five stars but a "Bronze" Analyst Rating.
3. Understanding Nuance: Sarah researches why "Growth Equity Fund A" has a Gold rating. Morningstar's analysis reveals that its portfolio manager has a long, successful tenure, a clearly defined investment process, and the fund is backed by a reputable parent company. For "Innovators Fund B," the Bronze rating might be due to recent manager changes or a less consistent investment process, despite its strong past performance.
4. Decision: Based on this comprehensive view, Sarah decides to allocate a portion of her portfolio to "Growth Equity Fund A," valuing the forward-looking qualitative assessment alongside the historical quantitative performance. She also considers how this investment fits within her overall diversification strategy.

Practical Applications

Morningstar's research and ratings are applied across various facets of the financial world. Individual investors frequently use Morningstar.com to research and compare investment products before making allocation decisions within their retirement accounts or brokerage portfolios. Financial advisors leverage Morningstar Direct and Advisor Workstation to conduct in-depth analysis, construct client portfolios, and provide tailored financial planning advice.

Asset managers and fund companies also utilize Morningstar's data and tools for competitive analysis, product development, and to benchmark their own offerings. For instance, Morningstar Indexes provides benchmarks for asset managers and ETF providers. Additional³ly, institutions like IGM Financial, a large Canadian asset and wealth management company, have their credit ratings confirmed by DBRS Morningstar, highlighting the firm's role in institutional credit assessment. News outle²ts and financial publications frequently cite Morningstar data and analysis to provide context on market trends and company earnings, offering investors insights into various market segments, such as Asian equities.

Limita¹tions and Criticisms

Despite its widespread use, Morningstar's star rating system, specifically, faces certain limitations and criticisms. A primary critique is that the star ratings are purely backward-looking, meaning they reflect a fund's past performance and do not guarantee future results. A fund that performed exceptionally well in one market cycle might not replicate that success in another. This can lead to a "herding" effect where investors chase past performance, which is often contrary to sound portfolio theory.

Another point of contention revolves around the categorization of funds. While Morningstar strives for accurate peer grouping, the classification can sometimes be subjective, potentially leading to funds being compared against inappropriate benchmarks. Critics also highlight that the quantitative nature of the star rating does not fully account for qualitative aspects like the skill of the fund manager, changes in investment strategy, or the long-term viability of the fund's parent company. While Morningstar addresses some of these concerns with its forward-looking Analyst Ratings, the simplicity and prominence of the star rating can sometimes lead to an overreliance on a single metric, potentially overlooking other crucial factors in due diligence.

Morningstar vs. Morningstar Rating

It is important to distinguish between Morningstar, the financial services company, and the Morningstar Rating™ (often called the "star rating"), which is one of the company's most prominent products.

• Morningstar (The Company): This refers to Morningstar, Inc., the global firm that provides a wide array of investment management, research, and data services. Its offerings span various asset classes and investment vehicles, including stocks, bonds, mutual funds, and ETFs. The company develops software tools, publishes research, and offers advisory services. Morningstar's mission is to empower investor success by offering independent analysis and solutions.
• Morningstar Rating (The Product): This is a specific, quantitative rating system developed by Morningstar to assess the historical risk-adjusted return of mutual funds and ETFs. It uses a one-to-five star scale, with five stars indicating superior past performance relative to peers after accounting for risk. The Morningstar Rating is a tool provided by Morningstar, not the entirety of what the company does. Confusion often arises when investors treat a fund's star rating as a prediction of future performance, rather than a historical measure.

FAQs

Q: What is the Morningstar Star Rating based on?

A: The Morningstar Star Rating is a quantitative measure based on a fund's historical risk-adjusted return over three, five, and ten years, compared to funds within its specific Morningstar Category. It assesses how well a fund has performed relative to its peers, considering the level of risk it undertook.

Q: Does a five-star Morningstar Rating guarantee future performance?

A: No, a five-star Morningstar Rating does not guarantee future performance. It is a backward-looking measure that reflects a fund's past performance. Investment outcomes can be influenced by various factors, and past performance is not indicative of future results. Investors should consider a range of factors beyond just the star rating, including the fund's objectives, fees, and the overall economic environment.

Q: What is the difference between the Morningstar Star Rating and the Morningstar Analyst Rating?

A: The Morningstar Star Rating is a quantitative, backward-looking assessment based on historical performance. The Morningstar Analyst Rating, conversely, is a qualitative, forward-looking assessment made by Morningstar analysts. It reflects their conviction in a fund's ability to outperform its benchmark on a risk-adjusted basis over a full market cycle, considering factors like the fund's management, process, and parent company.

Q: Can I use Morningstar to research individual stocks?

A: Yes, Morningstar provides extensive research and data on individual stocks, including financial statements, analyst reports, fair value estimates, and news. This information can assist investors in conducting their own fundamental analysis.

Q: Is Morningstar an independent research firm?

A: Yes, Morningstar positions itself as an independent investment research firm. Its business model relies on selling data, software, and research to both individual and institutional clients, aiming to provide objective analysis separate from fund companies or brokerage firms.