Morningstar - Q3 2022 - 10

Dispatches
EXHIBIT 4
EXHIBIT 5
Analyst Rating Average Annual Excess
Return vs. Category Average
Œ
„
Œ
„
Œ
„
´
‰ Á
´
‰ Á
´
‰ Á
Average
Excess Return
AverageAverage
Excess Return1.2%
1.2%
Excess Return
1.2%
0.8
0.80.8
0.4
0.40.4
1 Year
0 0
-0.4
1 Year
1 Year1 Year
3 Year
3 Year3 Year
5 Year
5 Year5 Year
10 Year -0.4
Source: Morningstar Direct. Data as of 02/28/2022.
10 Year10 Year
-0.4
1 Year1 Year
3 Year3 Year
3 Year
5 Year5 Year
Note: Includes all rated funds at beginning of each event horizon
between 11/01/2011 and 01/31/2021.
Source: Morningstar Direct. Data as of 02/28/2022.
0 0
5 Year -0.25
-0.25
Average Annual Event-Horizon Excess
Return vs. Category Average
Œ
„
Œ
„
Œ
„
´
‰ Á
´
‰ Á
´
‰ Á
Average
Excess Return
AverageAverage
Excess Return
Excess Return
1.00%
1.00%
0.25
0.50
0.75
0.25
0.50
0.75
0.25
0.50
0.75
-0.25
1 Year
1 Year1 Year
3 Year
3 Year3 Year
5 Year
5 Year5 Year
Note: Includes all rated funds at beginning of each event horizon
between 11/01/2011 and 01/31/2021.
Source: Morningstar Direct. Data as of 02/28/2022.
1.00%
EXHIBIT 6
Average Annual Event-Horizon Excess
Return vs. Category Index
Œ
„
Œ
„
Œ
„
´
‰ Á
´
‰ Á
´
‰ Á
Average
Excess Return
AverageAverage
Excess Return 0%
0%
Excess Return
0%
-0.75
-0.50
-0.25
-1.00
-0.75
-0.50
-0.25
-1.00
-0.75
-0.50
-0.25
-1.00
funds against their assigned category benchmark
index ( EXHIBIT 6 ).
We also evaluated the risk-adjusted performance
of funds assigned Analyst Ratings. In this
analysis, we calculated CAPM alpha success
ratios-the percentage of rated funds that started
a period, survived to the end, and generated
positive alpha versus their category index-across
the ratings cohorts. We found that medalists
succeeded about one-and-a-half times as
often over the trailing periods ended Feb. 28, 2022.
Morningstar Quantitative Rating
The Quantitative Rating for funds uses algorithmic
techniques to infer the rating a manager
research analyst would assign to a fund if they
covered it. It does so by studying relationships
between analysts' ratings-assignment tendencies
and the characteristic of the funds they're
assigning those ratings to. By applying those
lessons to the universe of funds that analysts don't
cover, the Quantitative Rating emulates what
an analyst might assign.
Though the Quantitative Rating is still relatively
new, having launched only in 2017, the early
results have been encouraging. It has done a good
10
Morningstar Q3 2022
job of sorting funds based on their future
performance (EXHIBIT 7 ).
Though performance has been weaker recently,
the pattern held even when we tallied funds'
average excess returns against their assigned
benchmark index, with higher-rated funds lagging
by less than lower-rated funds (EXHIBIT 8 ).
Funds not covered by analysts tend to be
smaller, less tenured, and costlier, on average.
Given that, they die more often than covered funds,
making it worthwhile to examine trailing
success rates, which take dead funds into account.
Higher-rated funds succeeded more often
than lower-rated funds, in part because they were
much likelier to survive (EXHIBIT 9 ).
This also held true when we examined the riskadjusted
performance of funds assigned
Quantitative Ratings. Medalists generated positive
CAPM alpha (versus their assigned category
index) more often than nonmedalists.
It's worth noting that one of the reasons the
Analyst Rating and Quantitative Rating
have sorted well based on future performance is
because fees play an important role in each
methodology. The costlier a fund, the lower its
rating is likely to be, and vice versa. We
consider this a feature, not a bug, of each rating
system, as our research has found fees to be
one of the most predictive variables.
Morningstar Sustainability Rating
Unlike the other ratings systems, the Sustainability
Rating's primary objective isn't to sort funds
based on future performance. Rather, it aims to
denote how much material unmanaged ESG
risk a fund's holdings are courting compared with
other funds like it.
The Sustainability Rating is still relatively new-
the current methodology was rolled out in
2019-so it's difficult to draw firm conclusions on
how well it has sorted funds based on future
performance. Nevertheless, it is worth assessing
its success so far.
Though the Sustainability Rating has sorted well
recently, higher-rated funds (those with lower
ESG risk) have not outperformed their average peer
by larger margins than lower-rated funds
since the rating's inception. That said, there's no
evidence that investors who have sought
to minimize ESG risks have incurred a large
Morningstar - Q3 2022

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