Sunday, June 12, 2011

Morningstar Introduces New Ratings for Mutual Funds

For those unfamiliar with Morningstar, it offers a 1-5 star rating system for mutual funds based off past performance for 1-, 3-, 5-, and 10-year time frames and is highly regarded in the industry by both individual and institutional investors alike. Previously, Morningstar did not offer any forward-looking analysis. Today, they announced a new outlook system similar to the outlooks given by ratings agencies such as S&P or Moody's. Funds will be assigned a positive, neutral, or negative outlook based off of analyst recommendations.

This development will add an entirely new dynamic to analyzing mutual fund companies. Funds with better outlooks will likely be more attractive to prospective investors, thus improving (or conversely, worsening) organic inflows. Depending on the frequency of outlook changes, this change could greatly increase the volatility of an already-volatile industry. The specifics of how Morningstar will use the "Five Pillars" - process, performance, price, people, and  parent - are yet to be seen, but it will certainly be interesting to see if/how it will influence fund managers and their investment strategies.

We sold out of TROW at our last conference call, so we currently do not have any direct exposure to the industry. I will stay on top of this as more information becomes available. If it looks like TROW will materially benefit from the new ratings, I will reconsider a position.


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