How should investors use Morningstar mutual fund ratings/grades to select mutual funds? In his July 2014 paper entitled “Morningstar Mutual Fund Measures and Selection Model”, John Haslem surveys the five kinds of Morningstar mutual fund ratings and grades: (1) Morningstar star ratings (one to five stars); (2) analyst ratings (gold, silver, bronze, neutral and negative); (3) total pillar ratings ( positive, neutral or negative for fund people, process, parent, performance and price); (4) upside/downside capture ratios; and, (5) stewardship ratings (culture, incentives, fees, board quality and regulatory history). Based on the body of research about the predictive power of Morningstar ratings/grades, he chooses three criteria for screening mutual funds:
- Star rating of 4 or 5 and analyst rating of gold or silver.
- Upside capture ratios greater than downside capture ratios for all three of 3-year, 5-year and 10-year past performance intervals.
- Total stewardship grade of A.
He applies these criteria to the set of Vanguard actively managed diversified (not sector) U.S. equity mutual funds. His selections are current winners, with empirical testing requiring future performance data. Applying the chosen criteria to the specified set of Vanguard funds, he finds that: Keep Reading