An Anatomy of Morningstar Ratings

Chicago-based Morningstar Inc. rates the investment performance of mutual funds using a rating system of one to five stars. This article first documents the method Morningstar uses in assigning these widely circulated ratings. It then establishes that (1) a fund with a long history is less likely to receive the top rating of five stars than a fund with a short history and (2) nearly half of the no-load, diversified, domestic equity funds receive an overall Morningstar rating of four or five stars whereas slightly more than a quarter of these funds receive one or two stars. The disproportionate number of high ratings for these funds is a result of the interaction between the broad comparison group Morningstar uses in its rankings and the handicaps it gives to load and specialized equity funds.