ETF Performance Is Not All Written in the Stars
A look at how the Morningstar Rating for funds applies to ETFs.
The Morningstar Rating assigns 1 to 5 stars to a fund based on its risk-adjusted-return ranking compared with funds in the same Morningstar Category. In contrast to the forward-looking Morningstar Analyst Rating, the Morningstar Rating for funds is a completely backward-looking statistical measure of performance. The breakpoints between the five levels are determined so that approximately 10% of the funds in each category earn 1 star, 22.5% earn 2 stars, 35% earn 3 stars, 22.5% earn 4 stars and 10% earn 5 stars. The distribution is symmetrical and bell-shaped, with very few funds receiving either a 1- or 5-star rating.
Because the star rating was originally designed before the widespread popularity of exchange-traded funds, the breakpoints are still based solely on mutual funds, and then ETFs are slotted according to those same breakpoints. Thus, ETFs are not forced to follow that same bell-shaped distribution. Of the 152 U.S. equity ETFs that have been around long enough to have a five-year rating, 39 have earned 5 stars while just four ETFs have 1 star. In fact, 75% of ETFs have 4 or 5 stars while just 7% have 1 or 2 stars.
Michael Rawson does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.