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By Christine Benz and Russel Kinnel | 10-08-2012 03:30 PM

Have Questions About Morningstar's Analyst Ratings?

Morningstar's Russ Kinnel tackles common questions related to our qualitative fund ratings system and details how Morningstar's analysts help investors with a specific rating.

Christine Benz: Hi, I'm Christine Benz for Morningstar Analyst Ratings for funds are a terrific addition to investors' toolkits. Here to provide an overview of the ratings is Russ Kinnel. He is director of fund research for Morningstar.

Russ, thank you so much for being here.

Russ Kinnel: Good to be here.

Benz: Russ, I know that one question that you have been getting a lot about the rating is how is this different from the old star rating system that we've had for many years? Let's talk about the key difference between the two rating systems.

Kinnel: Well, I think if you think about it, they are really complementary. So the [Morningstar Rating for funds, or star rating] is a purely quantitative, risk-adjusted measure of past performance over the trailing three, five, and 10 years. So we analysts have no input on that. It's just purely a measure of how the fund has done in the past. The qualitative rating, however, is very different. It's as I said, qualitative. It's the analysts' view on the quality of management strategy, price, performance, and parent, all these things rolled up, with the idea of what's a fund's key competitive advantages or lack thereof, and what's a fund's long-term prospects going forward.

Benz: So the goal of the rating is to try to help investors identify funds that will outperform over time?

Kinnel: That's right. We're trying to tell people, these are funds with great chances for long-term, risk-adjusted outperformance. We're not trying to say, "This is a fund that's going to great next year or next week." [We say] "This is a fund where the fundamentals give it a good chance of success."

Benz: Russ you mentioned the five pillars of the rating system; that's people, process, parent, price, and performance. Are those equal-weighted? How are the analysts looking at those five pillars?

Kinnel: That's another question we get a lot, and the answer is no, they are not equal-weighted. So, you can't simply look at them and sum them up because in each case it's different. You look at fund like Fairholme. Clearly, the manager and the process are a huge part of it. If you look at an index fund, clearly the fees are a big part of it. So, each one really comes together in a different way. The analysts and the ratings committees that I head try to sort out what's the way to put that together; overall what are the fund's prospects? And then in each case it's different, and even though we have five pillars, I think of them as working together. So, [for example] process and people: Does that give the fund a competitive advantage? Is this a strategy that the managers really can do better than others?

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