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Our Mostly Patient Approach to Analyst Ratings

See how the analyst ratings and star ratings for funds change over time.

Russel Kinnel, 04/01/2013

It has been 13 years since we introduced Fund Analyst Picks, 10 years since we introduced more rigor, including a vetting committee, and just more than one year since we transitioned to the Morningstar Analyst Rating. That gives us a broad swath of time to look at how we rate funds.

In order to illustrate the process, I chose a handful of funds that have been picks or Gold-rated over the years and examined the ratings, performance, and Morningstar Ratings for funds, or "star ratings," over that same time. As you'll see, the picks and Analyst Ratings change far less often than the star ratings.

The star rating is a quantitative measure of a fund's load-adjusted and risk-adjusted performance relative to category peers over the trailing three-, five-, and 10-year periods. In contrast, the Morningstar Analyst Rating is a qualitative fundamental-driven look at a fund's long-term prospects. The star rating is updated monthly, while the Analyst Rating is subject to revision at any time by our analysts and ratings committee. For example, we recently lowered T. Rowe Price Health Sciences PRHSX to Neutral from Gold because the manager left and took two analysts with him. 

While we keep a close eye on funds, we are also patient. Thus, the Analyst Rating and the picks before it tend not to change nearly as often as the star rating. The Analyst Rating reflects things not taken into account by the star rating, such as manager changes, changes in expense ratios, the quality of the fund company, and returns outside of those three-, five-, and 10-year periods. We generally focus on the manager's track record over the entire time he or she was at the fund as well as at other funds or separately managed accounts.

Thus, while most of our Gold-rated funds are 4 or 5 stars, there are some with lower star ratings.

Click on this link to see the graphs for each of the following funds. These exhibits chart the changes in analyst rating and star rating against performance.

Harbor Bond HABDX
Sometimes it is that simple. We made Harbor Bond an Analyst Pick in 1999 and have given it our top rating ever since. It's the most accessible, cheapest retail version of PIMCO Total Return PTTRX, and we've long been fans. By 1999 Bill Gross had already won our Manager of the Year award, and most other taxable-bond funds neither could match PIMCO for resources nor Bill Gross for skill.

Even though the rating seems like a no-brainer with hindsight, it was controversial just a year ago. A bad call led to dismal relative performance in 2011, and many reporters and investors alike said PIMCO Total Return was too big. The star rating dropped to 4, and it only recently returned to 5. We believed that the bad call was the problem, not asset size, and we've seen the fund recover from other bad calls, so we stuck with it. Even someone as good as Bill Gross is going to make errors from time to time. When we evaluate managers, we look to see if their mistakes are within the realm of reasonable expectations and whether they indicate something important has broken down. This fund passed the test, and we kept it a Gold fund. From 1999 the fund has beaten its average category peer by 1.3% annualized.

Russel Kinnel is Morningstar's director of mutual fund research. He is also the editor of Morningstar FundInvestor, a monthly newsletter dedicated to helping investors pick great mutual funds, build winning portfolios, and monitor their funds for greater gains. (Click here for a free issue). Mr. Kinnel would like to hear from readers, but no financial-planning questions, please. Follow Russel on Twitter: @russkinnel.

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