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By Morningstar | 03-21-2015 12:00 PM

Morningstar Medalists: What Makes the Best Funds Shine

Learn how Morningstar's independent analyst team rates and continuously monitors mutual funds, so you can find the best investments for your portfolio.

Narrator: The mutual fund landscape can be overwhelming. There are more than 8,000 funds to choose from, spread out among dozens of investment categories. Add to that the pressures of stock-market fluctuations, interest-rate movements, and global economic developments, and the stage is set for investors to make poor investment choices--or not to invest at all.

Instead of being worried about what is going to happen next quarter or even next year, investors, advisors, and institutions can use the Morningstar Analyst Ratings to find the industry's best funds--what we call Medalist funds--that will help them build solid strategic portfolios that will endure over time.

Over the next few minutes, we'll explore how the Analyst Rating differs from the star rating for funds, the components of the Analyst Rating (what we call the Five Pillars), how we monitor ratings, and how you can use Medalist-rated funds to upgrade your portfolio.

Morningstar has been analyzing mutual funds for more than 30 years. Morningstar's first fund rating, known to investors as the "star rating," made its debut in 1985.

Jon Hale, Director of Manager Research: The star rating is a measure of funds' historical risk-adjusted performance relative to a peer group. It's a purely quantitative measure that is applied to every single fund, every single share class of a fund, once it gets to a three-year record. So every fund in the universe with a three-year record has a star rating.

Stars are allocated in a normal fashion, meaning that fully one-third of all the fund share classes out there have 3 stars, one third have 5 or 4 stars (those are the best ratings), and a third have 2 or 1 stars, the worst ratings. Only about 10% to 12% of funds at any given point in time have a 5-star rating.

Narrator: In 2011, Morningstar introduced the Morningstar Analyst Rating for Funds, also known as the Analyst Rating. Funds that earn the highest Analyst Ratings are called Medalist funds.

Russ Kinnel, Director of Manager Research: We consider Medalists to be funds that are likely to outperform their peers and their benchmark on a risk-adjusted basis over a full market cycle. We rate funds Gold, Silver, and Bronze based on our conviction of the likelihood that the fund will outperform.

Michael Herbst, Director of Manager Research: The star rating is essentially an achievement test. It's a backward-looking, strictly quantitative measure of risk-adjusted performance.

The Morningstar Analyst Rating is an aptitude test--that is, looking forward how well do we think a certain fund will do versus its competitors or its benchmark.

Kinnel: The Analyst Rating and the star rating are often going to be in sync because a fund's track record is going to point you in the direction you want to go. But sometimes there is a big divergence. Let's say the manager who is responsible for all of that fund's past success has gone, and a new person has come in who really didn't have much to do with that success. Then, obviously, there is a good reason for the star rating and the Analyst Rating to diverge, and the Analyst Rating might be less positive than the star rating.

Narrator: Despite being forward-looking, Morningstar's Analyst Ratings are not short-term market recommendations. Nor are they market calls on fund categories or asset classes that Morningstar thinks might do well in the short term.

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