Morningstar began issuing "Analyst Ratings" of mutual funds back in November. The intent was to supplement, but not replace, its well-known 1- to 5-star ratings. So far, Morningstar has assigned analyst ratings to 850 funds. It plans to rate a total 1,500 by the end of this year.
Here's a look at the ratings:
—Goal: Analyst ratings are intended to give investors a sense of a fund's prospects, rather than just summarizing past results. Star ratings are based on quantitative measures, including investment returns measured against the performance of similar funds, and the level of risk the fund took to achieve those returns. The analyst ratings incorporate past returns, but also consider qualitative factors to gauge how a fund is likely to perform over at least the next five years. In essence, star ratings reflect what a fund has accomplished, while analyst ratings are an assessment of what's in store for the fund.
—Ratings scale: Funds are rated on five levels. Three are considered positive: Gold funds are best-of-breed funds, with strengths in all of the five factors that analysts consider in assessing funds, referenced below; silver funds have notable advantages across the five factors, but perhaps not in all of them; and bronze funds possess advantages that outweigh any disadvantages. The two other ratings are "neutral," indicating a fund isn't likely to deliver standout returns, either for the better or worse; and "negative," a fund with at least one significant flaw deemed to make it inferior.
— Methodology: Analysts assess funds based on five factors:
People: The quality of a fund's investment team, including its managers and analysts;
Process: The strengths of the fund's portfolio construction and investment selection, including whether strategy is implemented effectively;
Parent: The quality of the company running the fund, including its record of acting in fund shareholders' interests;
Performance: The fund's long-term investment returns compared with those of peers, and the consistency of returns in different market conditions; and
Price: The investment fees the fund charges, relative to those at similar funds.
—What's rated: The analyst ratings are assigned to funds that are new and old. That differs from the star ratings, which Morningstar assigns only to funds with performance records of at least three years.