Morningstar Tells Us (Again) That Their Ratings Have No Predictive Power But Some People Never Seem to Listen

The WSJ carries an interesting but strange article about an adviser who "bucked the trend" by investing in a mutual fund rated with only one star from Morningstar. The interesting thing to me is that this "investment professional" would take the morningstar rating as a serious input into the portfolio allocation. It is also disappointing that the WSJ would think it newsworthy that the morninstar ratings are useless in predicting future performance. The head of morningstar's mutual fund research makes this clear in the article and a careful reader of material from morningstar for years (as well as academic research) would have know this for at least a decade.

This still doesn't stop many of my colleagues from using morningstar software called principia and screening for funds with high "star ratings' when constructing portfolios. In my portfolios I only use index funds or etfs and I never check their ratings although I may compare those index investment vehicles in the same asset class with regards to fees and index methodology.

My bolds and italics



A Financial Adviser Bucks Star Power
Morningstar Is Just a Guide, He Says

By DAISY MAXEY
When David Kudla, chief investment strategist at Mainstay Capital Management, added a mutual fund that had been given a Morningstar rating of just one star to clients' portfolios last December, some called to question his decision.

DAVID KUDLA
"Some were appalled by it," Mr. Kudla said of his adding White Oak Select Growth (trading symbol WOGSX), which then carried Morningstar's lowest rating, to some of the financial-advisory firm's accounts.
He chose the fund because Mainstay expected technology, in which the White Oak fund is heavily weighted, to be among the sectors performing well in 2009, said Mr. Kudla, also the company's chief executive.

...

I'm not sure that if the above was one's outlook the more appropriate decision would be to add weighting of technology through an allocation to one of the technology etfs with style purity and lower fees.

Mr. Kudla says the fund's performance and rating underscore an important point: Morningstar ratings can be especially misleading at market inflection points.
"A rating based on the performance of an aggressive-growth equity fund, which includes the worst bear market since the Great Depression, was not a good indicator of how that fund was about to perform in 2009," he said. Mr. Kudla takes Morningstar ratings into consideration, but only as one factor among many

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and here is the quote from morningstar treated as if it is a new revelation or admission when in fact it has been stated numerous times over the year (although I would be the first to admit morningstar does give mixed messages.

Russel Kinnel, director of mutual-fund research at Morningstar, said the ratings are meant as a quick summary of past risk-adjusted performance and don't have "any great predictive power." Morningstar has found, however, that five-star funds generally perform better than one-star funds, and that the ratings are more predictive when there is a "smoother patch" in stock-market volatility, he said.
The ratings can be a good way to quickly check a portfolio, Mr. Kinnel said. "If a fund is one star, you'd want to know why it's doing so poorly; there could be a good reason," he said. In contrast, Morningstar's analyst "picks and pans" indicate which funds the investment-research firm's analysts believe investors should and shouldn't buy, he said

I'm not sure about the picks and pans either both because I haven't seen any data with their track record and because Morningstar gioves a mixed message on picks and pans since some of the picks are active funds but morningstar consistently speaks positively about the advantages of index instruments over actively managed mutual funds