The most common reason is that Morningstar takes expense ratios from latest audited annual reports only. The reason for this is expense ratios from audited annual reports are audited and annualized. The other sources may provide data from the prospectus or semiannual reports. These ratios are estimates, while annual report numbers are actual expense ratios.

The annual expense ratio expresses the percentage of assets deducted each fiscal year for fund expenses, including 12b-1 fees, management fees, administrative fees, operating costs, and all other asset-based costs incurred by the fund. Portfolio transaction fees, or brokerage costs, as well as initial or deferred sales charges are not included in the expense ratio.

At Morningstar we assume reinvestment of dividends on the last day of the month for both mutual funds and indexes. This provides an apples-to-apples comparison between a fund’s total returns and the S&P 500 total returns of the S&P 500. Other sources do not assume reinvestment of dividends when calculating returns for the index.

A note about the Standard & Poor’s 500 Index:

The S&P 500 is a market-capitalization-weighted index of 500 widely held stocks often used as a proxy for the stock market. It measures the movement of the largest issues. Standard & Poor’s chooses the 500 companies that comprise the index based on market size, liquidity, and industry group representation. Included are the stocks of industrial, financial, utility, and transportation companies. For more information, visit the Standard & Poor’s Web site.

At times the total returns that we calculate for a mutual fund may differ from a total return calculated by another data provider or from one supplied by the fund itself. Some possible reasons for this include:

Time period differences : often the difference is due simply to time-period discrepancies. For example, a fund that issues its annual report in late 2004 for its fiscal year ended September 30 may list a 2004 return based on the period from October 1, 2003 to September 30, 2004. Because we calculate annual total returns for all funds on a calendar basis, to allow valid comparisons between funds, the 2004 return we list for a fund won’t match its fiscal-year-end calculation. Similarly, some newspapers and financial magazines may choose slightly different dates or may publish preliminary data in order to fit their publication schedules.

Calculation differences: Morningstar calculates total returns by reinvesting all distributions at the NAV (price per share) on the reinvestment date used by the fund. We then compound the funds monthly returns and annualize the figure for time periods greater than one year. Other firms may employ different methodology. For example, some services reinvest all dividends at month-end prices. Morningstar takes the extra step to obtain the actual reinvestment price that an investor in the fund would receive for reinvesting distributions into additional shares. When reinvestment prices are not available, we assume reinvestment at the market price on, or as close as possible to, the dividend-payment date.

Pure math. A fund’s Morningstar Rating is based solely on a formula that Morningstar recalculates each month--there is no subjective input. The loss of a star doesn’t mean someone at Morningstar has downgraded the fund--it simply means the fund’s relative performance is currently below the cutoff point for its previous rating. Nothing more, nothing less.

Time to panic? Nope. You didn’t buy the fund just because of its star rating (we hope), and you shouldn’t sell solely because of its rating, either. There are several reasons for changes in a fund’s rating that have little to do with its management and absolute performance:

• A fund may lose one or more stars when it reaches its fifth or 10th birthday because Morningstar calculates the overall star rating by combining the star ratings for three years, five years, and 10 years. For example: if the fund has poor performance in its fourth & fifth years, when the fund reaches its fifth birthday fifth year performance becomes part of the rating, and the overall rating of the fund might decrease. Conversely, for some funds, the rating will improve when it turns five years old.
• A fund may lose a star if it is very close to the rating breakpoint and its peers in the category generally outperformed it in the recent past. In this case the loss of a star simply means the fund's relative performance is currently below the cutoff point for its previous rating.
• The number of funds in the category will fluctuate and can have an effect on a fund’s star rating. New funds are activated each month and removed from publication. This could be beneficial or detrimental to a fund’s rating since the rating is determined relative to a fund’s peers.

• Morningstar provides daily pricing information for the New York Times, AP, and for other newspaper mutual fund tables. The requirements for being printed in the New York Times are currently active share classes with more than $150 million in net assets for the daily paper and $30 million for the weekend paper.
• The fields that are printed in the New York Times are daily NAV, daily share change %, YTD return, and footnotes on expenses, splits, and distributions.
Morningstar only receives total net assets at month end, so it is possible for a fund to reach $150 million in the middle of the month but that fund would not show up in the paper until the end of the month when we receive the new total net assets.

These two indicators of investment style will sometimes differ because they examine different time periods. The style box is based on the most recent portfolio provided to Morningstar. The Morningstar category is based on an average of three and five years of portfolio data(12 quarterly portfolios or 36 monthly portfolios if available).

A discrepancy between a fund's category and its style box indicates a change from a previous investment style that may or may not be temporary. For example, if a manager has favored small-cap stocks over time but is now currently leaning toward mid-cap stocks, the fund may be listed in the small-cap growth category while its style box will be mid-cap growth. This could also occur if a manager’s small-cap holdings have grown to be mid sized companies.

When making historical performance comparisons, use the Morningstar category. To determine the most current investment style of a fund, use the Morningstar Style Box. If a fund’s style continues to show a trend towards another Morningstar category, our editorial analysts may elect to move it to that category.

• Twice a year a quantitative program is run for the entire universe of funds in the Morningstar database to determine which funds need to change categories. This program is based strictly on portfolio statistics. Morningstar’s editorial team reviews the funds that the program indicates should change and then approves or rejects the changes. The category reviews are performed for all the open-end funds twice a year in May and November. For funds that are less than 12 months old, the category is reviewed quarterly. During the biannual category reviews, if a fund’s category is changed, notification of that change will be sent to the fund family. The fund’s management can appeal the category change by contacting the editorial analyst. If the fund is a new fund in our system and we don’t have a history of portfolio holdings, the category will be assigned using the investment policy section in the fund's prospectus.
• Some factors that can result in category changes include:
1. A fund merged with another fund.
2. A new manager takes over the fund, and this results in an investment policy / style change.
3. A fund changes names, and the name change reflects a shift in the fund's strategy.

In cases where we move a fund to a different category, we will assign less weight to historical performance for the longer time periods when calculating the star rating.

In an effort to distinguish funds by what they own, as well as by their prospectus objectives and styles, Morningstar developed the Morningstar categories. While the prospectus objective identifies a fund’s investment goals based on the wording in the fund prospectus, the Morningstar category identifies funds based on their actual investment styles as measured by their underlying portfolio holdings (portfolio statistics and compositions over the past three years). If the fund is new and has no portfolio, we estimate where it will fall before assigning a more permanent category. When necessary, we may change a category assignment based on current information.

• Morningstar requires several pieces of information from the fund company or its transfer agents before we can activate a fund in our database. A fund must be designated as "active" to be included in Principia Pro and our other products.
• To become an active fund in Morningstar’s database the fund must have all the following:
1. Complete performance history for the fund from its inception date. This includes all daily net asset values, dividends, and capital gains (broken out between long-term and short-term gains).
2. A commitment to provide on an ongoing basis
1. A daily file containing the closing NAVs and all distributions.
2. A monthly file containing month-end NAVs, dividends, capital gains, reinvestment dates, and total net assets.
3. Verified Returns: All of the returns for the fund must be verified before fund can be activated in the database.
4. An initial portfolio so that we can place the fund in the appropriate category.
5. Fees, expenses, and purchase information such as loads (front-end, deferred), expense projections, expenses (12b-1, management, advisor, administrative, subadvisor), and min/max investment amounts contained in the prospectus, statement of additional information and annual reports.

The Morningstar Rating for mutual funds, commonly called the "star rating," brings both performance and risk together into one evaluation. Morningstar adjusts for risk by calculating a risk penalty for each fund based on "expected utility theory," a commonly used method of economic analysis. Although the math is complex, the basic concept is relatively straightforward. It assumes that investors are more concerned about a possible poor outcome than an unexpectedly good outcome and that those investors are willing to give up a small portion of an investment’s expected return in exchange for greater certainty. A "risk penalty" is subtracted from each fund’s total return, based on the variation in its month-to-month return during the rating period, with an emphasis on downward variation. The greater the variation, the larger the penalty. If two funds have the exact same return, the one with more variation in its return is given the larger risk penalty.

Funds are ranked within their categories according to their risk-adjusted return (after accounting for all sales charges and expenses), and stars are assigned such that the distribution reflects a classic bell-shaped curve with the largest section in the center. The 10% of funds in each category with the highest risk-adjusted return receive five stars, the next 22.5% receive four stars, the middle 35% receive three stars, the next 22.5% receive two stars, and the bottom 10% receive one star.

Funds are rated for up to three periods--the trailing three, five, and 10 years and ratings are recalculated each month. Funds with less than three years of performance history are not rated. For funds with only three years of performance history, their three-year star ratings will be the same as their overall star ratings. For funds with five-year records, their overall rating will be calculated based on a 60% weighting for the five-year rating and 40% for the three-year rating. For funds with more than a decade of performance, the overall rating will be weighted as 50% for the 10-year rating, 30% for the five-year rating, and 20% for the three-year rating. The star ratings are recalculated monthly.

For multiple-share-class funds, each share class is rated separately and counted as a fraction of a fund within this scale, which may cause slight variations in the distribution percentages. This accounting prevents a single portfolio in a smaller category from dominating any portion of the rating scale.

Significant changes were made to the rating methodology, effective June 30, 2002. Previously, funds were rated within one of four broad asset-class-based groups--U.S.-stock funds, international-stock funds, taxable-bond funds, and municipal-bond funds. The new methodology rates funds within much smaller comparison groups, their respective Morningstar categories.

The biggest impact of this change is that funds are less likely to receive a high (or low) rating due to a market "tailwind." For example, under the previous methodology, persistent outperformance by the value investment style resulted in high ratings for most value funds, while growth-oriented funds were likely to receive lower ratings. However, the change also means that some extremely risky funds will now receive five stars (those with the best risk-adjusted return within their category), which was difficult under the old methodology.

In addition, a new method is now used for risk adjustment. In the previous methodology, risk was defined by measuring the fund’s average underperformance relative to a guaranteed investment, the 90-day Treasury bill. If a fund’s return exceeded this benchmark each month, the fund was deemed riskless. Yet funds with highly variable returns are likely to eventually produce losses, even if they’re currently enjoying a run of success. Internet funds are a perfect example. Because they outperformed the Treasury bill for many successive months, they exhibited little downward risk in 1999; but they suffered huge losses in subsequent years.

The current methodology accounts for all variations in a fund’s monthly performance, with an emphasis on downward variation. It rewards consistent performance and reduces the possibility of strong short-term performance masking the inherent risk of a fund.

A fund must be at least three years old to have a Morningstar Rating.

The style box is a tool that represents the characteristics of a security in a graphical format. For stocks and stock funds, there are two pieces of data that determine where the security falls within the style box. One is market capitalization: how large or small a company is. Large companies show up in the top row of the style box, middle-sized companies show up in the middle row, and small companies show up in the bottom row.

The other factor that determines a security’s placement in the style box is its investment style. Investment style is based on a growth score and a value score. Half of a stock’s growth score is based on its long-term projected earnings growth relative to other stocks in its market-cap range. The remainder of the growth score is based on a combination of historical earnings growth, sales growth, cash-flow growth, and book-value growth relative to the stocks in its market-cap range. The resulting score will range from 0 to 100. Half of a stock’s value score is based on its price/projected earnings relative to other stocks in its market-cap range. The remainder of the value score is based on a combination of price-to-book, price-to-sales, price-to-cash flow, and dividend yield relative to the stocks in its market-cap range. This score will also range from 0 to 100.

Morningstar arrives at a stock’s investment style by subtracting its value score from its growth score. A stock with a strongly negative score is assigned to value, and one with a strongly positive score is assigned to growth. Those in between land in the core column of the style box (for funds, this is known as the blend column). The breakpoints can vary over time but, on average, each style will account for one third of the stocks in each market-cap range.

A stock mutual fund’s style-box position is based upon all of the stocks in its portfolio. The portfolio’s market cap is based on the geometric mean of the portfolio. That calculation takes the market cap of each stock and its weighting in the portfolio into account to come up with a number that best represents how the fund is positioned. The portfolio’s overall stock style is based on the weighted average of the style scores for all of its stocks (the weighting is based on the percentage of the portfolio each stock takes up). Funds with averages on the low side land in the value column, those on the high side land in growth, and those in between are blend.