Morningstar Finally Tells Us What Those Star Ratings Are(n't) Good For

The Wsj reports on a morningstar study that answers that question:

Low Fees Outshine Fund Star System

By JANE J. KIM

kudos to  morningstar for releasing the study. The results may be surprising to the many individual investors and, sad to say, professionals that rely on the morningstar ratings in choosing investments.

The conclusions should come as no surprise to any regular readers here or to anyone who has delved into the serious research on the subject of predicting mutual fund returns. Past performance is not a predictor of future performance, few funds consistently outperform their benchmark, and the most reliable determinant of performance is the level of expenses:

  from the article

Low fees are likely to be the best predictor of a mutual fund's future success, according to a new study by Morningstar Inc.
The study, to be released Monday, shows that using low fees as a guide would give investors better results than even Morningstar's own star-rating system, which looks at past risk- and load-adjusted returns. While the stars system has typically guided investors to better results, it isn't as effective in predicting future returns at times of big market swings.

Low-cost funds performed better on average than high-cost funds, Morningstar found.

Morningstar found that in aggregate, low-cost funds had better returns than high-cost funds across all asset classes, during various periods from 2005 through March 2010.
Fees "have proven to be the strongest predictor out there." says Russel Kinnel, director of fund research and author of the study. "The stars system, as a measure of past risk-adjusted performance, is going to be a little more limited."

That said I think morningstar does a great job of putting together data on mutual funds, coveing the mutual fund and etf industry and providing analysis of personal finance issues. Just dont use its ratings or recommendations in choosing a mutual funds. Of course if you take morningstar's own study to heart the ratings on actively managed funds will be irrelevant anyway as you will just be choosing from among index funds and etfs.