2002 Publishers Open Forum

Disclaimer

January 21, 2002
New Orleans, La.


Mutual Funds Information: A Product Review

Morningstar


Danielle Kemmer
Product Specialist
Morningstar, Inc.



Questions

1) If you rate mutual funds, what are your criteria?
2) How do you choose them?
3) How far back does the rating go?
4) What format do you use?
5) What are the features for exporting the data?
6) Do you provide NAVs?
7) Do you provide risk measures?
8) How does the product address ratings over time?
9) Do you provide total returns?
10) Do you provide tax adjusted returns?
11) Do you provide load adjusted returns?
12) Do you provide all this data for all companies or just a percentage of them?
13) Is it survivor bias free?
14) How do you evaluate? What criteria do you use?
15) Who do you view as your audience?


1) If you rate mutual funds, what are your criteria?

We have a rating system for both mutual funds and stocks.

Funds and stocks are different investment vehicles and therefore should be analyzed--and rated--differently. The Morningstar Rating for funds describes how well a fund has balanced return and risk or volatility in the past. The Morningstar Rating for stocks uses projections of a company's future operating performance to estimate whether the stock is overvalued or undervalued.

The Morningstar Rating TM for funds is purely quantitative; the analysts do not assign stars. We give funds two ‘scores’ based on their past performance: Morningstar Risk and Morningstar Reward. We subtract the risk score from the return score and then rank all funds in a group (domestic stock, international stock, taxable bond, municipal bond) according to the results. Funds with scores in the top 10% earn 5 stars; the next 22.5%, 4 stars; the middle 35%, 3 stars; the next 22.5%, 2 stars; and the bottom 10%, 1 star. Ratings are updated monthly.

The Morningstar Rating TM for stocks is more qualitative; it is based on our analysts’ estimates of a stock’s fair value. Morningstar analysts estimate a company’s growth rate, profitability, and the efficiency with which it uses its assets, and enters those estimates into a modified discounted cash-flow model. The result is an analyst-driven estimate of the stock’s fair value. Stocks with a fair value that is 30% or more above the current market price earn 5 stars; 10% to 30% above market price, 4 stars; within 10% (above or below), 3 stars; 10% to 30% below market price, 2 stars; and 30% or more below the current market price, 1 star. Ratings are updated daily.

For a more detailed look at the Morningstar Ratings TM for funds or stocks, see: http://news.morningstar.com/doc/article/0,1,5334,00.html and http://news.morningstar.com/doc/article/0,1,5140,00.html

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2) How do you choose them?

Morningstar Rating TM for funds:
Any fund which has at least 3 years of performance data will receive a star rating.

Morningstar Rating TM for stocks:
We rate the largest and most well-known companies we cover – currently, about 500 stocks. These are generally the largest companies in terms of market capitalization and sales across a sampling of industries. We also rate stocks that are popular among our customers.

We also write Analyst Reports about specific stocks and funds. There are currently about 1000 Stock Analyst Reports and 2000 Fund Analyst Reports. For more information on how we choose the funds and stocks our analysts cover in-depth:
Funds: http://news.morningstar.com/doc/article/0,1,2913,00.html
Stocks: http://news.morningstar.com/doc/article/0,1,4982,00.html

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3) How far back does the rating go?

The Morningstar Rating TM for funds is weighted based on the age of the fund. If a fund has a 3-year record bust hasn’t been around for 5 years, its overall Morningstar rating is based entirely on its 3-year rating. For a fund that has been around more than 5 years but less than 10 years, 60% of its overall rating is based on its 5-year rating and 40% on its 3-year rating. For a fund that is more than 10 years old, the overall star-rating formula is 50% 10-year rating, 30% 5-year rating, and 20% 3-year rating.

The Morningstar Rating TM for stocks uses projections of a company’s future operating performance to estimate whether the stock is overvalued or undervalued. It is a forward-looking measure.

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4) What format do you use?

We use the star system for rating both stocks and funds. 1 star is the lowest rating and 5 stars is the highest.

We publish the ratings in the following print products: Morningstar Mutual Funds TM, Morningstar® Stocks 500 TM, Morningstar® FundInvestor TM and Morningstar® StockInvestor TM. They are also available on our website, Morningstar.com® and through our software, Morningstar® Principia® Pro.

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5) What are the features for exporting the data?

You currently cannot export individual investment product data from our website. You can export portfolios to other formats, or you can print anything on the site.

There is limited data exporting available from Principia Pro.

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6) Do you provide NAVs?

Yes, NAVs are updated daily on the website. They are updated in the other products as the products are published. We also publish Variable Annuity/Universal Life subaccount AUVs on a monthly basis in the Morningstar Variable Annuities/Life Performance Report (print) and the VA/L module of Principia Pro.

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7) Do you provide risk measures?

For funds: The Morningstar Rating for funds, Morningstar Risk, Category Risk, Standard Deviation, Sharpe Ratio, Bear Market Decile Rank, and Modern Portfolio Theory (MPT) statistics – alpha, beta, r-squared. (binder, website and software)

For stocks: The Morningstar Rating for stocks, Morningstar Risk Measure for stocks (website and software) Standard Deviation, Bear Market Decile Rank (software)

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8) How does the product address ratings over time?

In relation to the calculation, see question 3.

Morningstar.com shows the 3, 5 and 10 year Morningstar Ratings for funds as well as the Overall Rating. The Morningstar Rating for stocks is updated daily and we indicate the change, if any, from the previous day’s rank.

The Morningstar Mutual Funds binder and Principia Pro show the 3,5 and 10 year ratings for funds, the Overall rating, and the Average Historical rating.

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9) Do you provide total returns?

(for funds)
Morningstar.com: Calendar Year Total Returns (7 years), Historical Quarterly Returns (7 years), Trailing Total Returns (1-day, 1-week, 1-month, 3-month, YTD, 1-year, 3-yr annualized, 5-yr annualized, 10-yr annualized) All relative to index and ranked within respective category.

Morningstar Mutual Funds (binder): Calender Year Total Returns (12 years), Historical Quarterly Returns (5 years), Trailing Total Returns (3-month, ,6-month, 1 year, 3-yr annualized, 5-yr annualized, 10-yr annualized, 15-yr annualized) All relative to index and category index and ranked both within respective category and complete universe of funds.

Principia Pro (software): Calender Year Total Returns (10 years), Historical Monthly Returns (since inception, only in Plus product), Trailing Total Returns (YTD, 1-month, 3-month, ,12-month, 3-yr annualized, 5-yr annualized, 10-yr annualized, 15-yr annualized) All ranked both within respective category and objective.

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10) Do you provide tax adjusted returns?

In Morningstar.com and in the Morningstar Mutual Funds binder, we provide the 3, 5 and 10-year Pre-Tax Return, Tax adjusted return, % rank within category, Tax Efficiency measure and Potential Capital Gains Exposure.

In Principia Pro, we provide Tax-adjusted Return (YTD, 1-month, 3-month, 12-month, 3, 5, 10 and 15-year), Tax Efficiency (3, 5, 10 and 15-year), and Potential Capital Gains Exposure.

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11) Do you provide load adjusted returns?

We provide 1,3,5 and 10-year load adjusted returns in the Morningstar Mutual Funds binder. In Principia Pro, we provide Load Adjusted Returns (12-month, 3, 5, 10-year, and Since Inception) calculated on both quarter-end and current month data.

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12) Do you provide all this data for all companies or just a percentage of them?

The data is published on all companies and funds covered. The only limitations are with the Morningstar Ratings, which is detailed above.

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13) Is it survivor bias free?

Not currently.

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14) How do you evaluate? What criteria do you use?

Morningstar takes a long-term, whole-portfolio view of investing. We want to educate investors both on evaluating individual investments, as well as how to evaluate their whole investment picture.

For simplifications sake, we can break down fund and stock analysis into 5 basic questions apiece:

Five Questions to Ask Before Buying a Fund

  1. How has the fund performed?
  2. How risky has the fund been?
  3. What does the fund own?
  4. Who runs the fund?
  5. What does the fund cost?


Five Questions to Ask Before Buying a Stock

  1. What Does the Company Do?
  2. How Fast Is the Company Growing?
  3. How Profitable Is It?
  4. How Healthy Are Its Finances?
  5. Is It Worth the Price?


To see full articles:
Five Questions to Ask Before Buying a Fund: http://news.morningstar.com/news/MS/Article/0,1299,3045,00.html
Five Questions to Ask Before Buying a Stock: http://news.morningstar.com/news/MS/Article/0,1299,3044,00.html

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15) Who do you view as your audience?

Our audience is as varied as the products we produce. Individual investors tend to be savvy 'do-it-yourself' investors who have at least a basic understanding of investing when first looking to Morningstar. However, that’s not to say that people just starting out will be lost in our products – we have extensive educational commentary and classes on our website to get people off on the right foot.

Morningstar.com®, Morningstar® FundInvestor TM, Morningstar® StockInvestor TM and the Morningstar® Stock 500 TM have all been designed with the individual investor in mind. Our editorial voice is independent, intelligent and easy to understand. These products combine commentary and data in a user-friendly format.

Morningstar® Principia® Pro is a modular software product designed for professional investors. Financial planners, advisors, and brokers will use this incredibly powerful database to do research for and track their client portfolios. Some individuals who are looking for a ‘number-crunching’ database also subscribe to Principia Pro.

Morningstar Mutual Funds TM and the Morningstar® Variable Annuities/Life Performance Report TM are designed for use by both individuals and investment professionals. They are terrific resource guides for information and data on mutual funds and variable annuity/universal life products.

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BRASS Business Reference Sources Committee

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Disclaimer : This publication has been placed on the web for the convenience of BRASS members. Information and links will not be updated. Posted 16 August 2002.