Morningstar Star Ratings Research Articles

Selecting the Best Mutual Funds

This article is based on the premise that forecasting mutual fund rankings on the basis of their historic performance record is a hazardous task. The authors evaluate the Morningstar star ratings as a selection criterion and explore whether other fund characteristics can improve the forecasting accuracy. They find that fund turnover and size are positively related to subsequent risk adjusted returns. It also appears that the funds with the higher tracking error rank more highly in the (risk adjusted) league tables. They conjecture that fund managers signal their skill by the aggressiveness with which they pursue their strategy. Equally important, funds with higher fees seem to earn just enough extra return to neutralize these extra expenses.

The Determinants of the Flow of Funds of Managed Portfolios: Mutual Funds versus Pension Funds

Due to differences in financial sophistication and agency relationships, we posit that investors use different criteria to select portfolio managers in the retail mutual fund and fiduciary pension fund industry segments. We provide evidence on investors' manager selection criteria by estimating the relation between manager asset flow and performance. We find that pension fund clients use quantitatively sophisticated measures like Jensen's alpha, tracking error, and outperformance of a market benchmark. Pension clients also punish poorly performing managers by withdrawing assets under management. In contrast, mutual fund investors use raw return performance and flock disproportionately to recent winners but do not withdraw assets from recent losers. Mutual fund manager flow is significantly positively related to Jensen's alpha, a seemingly anomalous result in light of a relatively unsophisticated mutual fund client base. We provide preliminary evidence, however, that this relation is driven by a high correlation between Jensen's alpha and widely available summary performance measures, such as Morningstar's star rating. By documenting differences in the flow-performance relation, we contribute to the growing literature linking fund manager behavior to the implicit incentives to increase assets under management. We show that several forces combine to weaken the incentive for pension fund managers to engage in the type of risk-shifting behavior identified in the mutual fund literature.