Though it has limitations, the star rating has, on balance, pointed investors toward funds they can succeed with.
Is the Morningstar Rating for funds, aka the star rating, a useful starting point for fund research? In this piece, which updates research we published most recently in November 2016, we'll address that question based on the evidence.
> The star rating is a straightforward "report card" based on funds' trailing risk-adjusted returns.
> Like any measure that relies on past performance, the star rating has limitations; the question is whether it's a useful starting point for research that points investors in the right direction.
> To assess the star rating's usefulness, we sought to determine whether the star rating pointed investors towards funds that they would be likelier to succeed with in the future.
> On balance, we found that the star rating points investors toward cheaper funds that are easier to own and likelier to outperform in the future, qualities that correspond with investor success.
> This finding held most strongly for allocation and taxable-bond funds; star ratings of U.S. equity funds exhibited less predictive power.
The star rating is a quantitative measure that ranks funds each month based on their trailing three-, five-, and 10-year risk-adjusted returns versus their Morningstar Category peers. (Until late 2016, the star rating calculation also adjusted returns for the effects of sales commissions paid to own a fund.)