Methodology Documents

Morningstar has conducted research on active and passive investment strategies and their associated vehicles since 1986.

This paper outlines the key assumptions and details behind our quantitative equity rating methodology.

We believe that a company's intrinsic worth results from the future cash flows it can generate. The Morningstar Rating for stocks identifies stocks trading at a discount or premium to their intrinsic worth--or fair value estimate, in Morningstar terminology.

This document describes the rationale for, and the formulas and procedures used in, calculating the Morningstar Rating for funds (commonly called the “star rating”). This methodology applies to funds receiving a star rating from Morningstar.

This paper outlines the key assumptions and details behind our quantitative equity rating methodology.

Morningstar developed the Morningstar Equity Comparables system to give investors and financial professionals an objective benchmark for comparing companies. Morningstar Equity Comparables is genuinely different to other industry classification schemes. We start from the bottom up with comparable companies, as opposed to the top down with sector definitions. For every pair of companies, we determine how similar they are–anywhere from closely comparable to distantly related based on automated analysis of the companies' own business description. We automatically analyse the text of the business description and work out whether companies are talking about similar things as they describe their businesses. Businesses described in similar terms are comparable.

Morningstar calculates investor returns for open-end mutual funds and exchange-traded funds to capture how the average investor fared in a fund over a period of time. Investor return incorporates the impact of cash inflows and outflows from purchases and

This study examines the extent to which investors are protected by share class limits, and how financial advisors who seek to fulfill their fiduciary and suitability obligations to their clients can determine which share class is suitable given the clien

This paper studies the role of commodities in a strategic asset allocation. There are several methods of obtaining exposure to commodities. This paper focuses on the type of exposure to commodities produced by a fully collateralized total return commodit

The Morningstar Ownership ZoneSM complements the style box to provide an additional layer of detail about an equity portfolio’s investment style.

Financial planners and advisors increasingly recognize that human capital must be taken into account when building optimal portfolios for individual investors. But human capital is not simply another pre-endowed asset class; it contains a unique mortalit

The Morningstar Rating™ for load-waived versions of the class A shares of mutual funds and other load-waived statistics better reflect the investor experience for those individuals who do not pay the fund's front-end sales load, such as retirement-plan p

This study measures historical equity returns over 42 years on the Japanese market by a supply-side approach using accounting data for 24 industries. It also demonstrates a method of constructing expected returns for the future. Equity return is generate

A number of risk-adjusted performance measures have been developed to address the shortcomings of the information ratio when active-return strategies are non-normal. These include the Sortino ratio, Omega, and the Stutzer index. The various risk-adjusted

The Black-Litterman model enables investors to combine their unique views regarding the performance of various assets with the market equilibrium in a manner that results in intuitive, diversified portfolios. This paper consolidates insights from the rel

During retirement, investors need to decide how to invest their savings among asset classes and possibly fixed payout annuities. The author explores retirement income solutions in a simple setting to illustrate the trade-offs that retired investors face

Morningstar uses the historical monthly total returns for the appropriate time period (one-, three-, five-, 10-, 15-, and 20-year) to calculate the monthly standard deviation for stocks, open-end mutual funds, closed-end funds, exchange-traded funds, ind

The Morningstar Tax Cost Ratio measures how much a fund’s annualized return is reduced by the taxes investors pay on distributions. In this paper we discuss how this is calculated.

Morningstar calculates potential capital gain exposure to give investors some idea of the potential tax consequences of their investment in a fund. PCGE estimates how much the fund’s assets have appreciated, and it measures the gains that have not yet be

Morningstar® Indexes were created to provide investors with accurate benchmarks for performance measurement, as well as offering discrete building blocks for portfolio construction. These indexes provide an accurate, comprehensive depiction of the perfor

This paper assesses the investment value of the CBOE S&P 500 BuyWrite (BXM) Index and its covered call investment strategy to an investor from the total portfolio perspective. Additionally, we compare standard investor portfolios to portfolios where BXM

The Sortino Ratio and the more recently developed Omega statistic are conceptually related “downside” risk-adjusted return measures, but appear distinct mathematically. We show that each of these measures is a special case of Kappa, a generalized risk-ad

The Morningstar Style Box™, sometimes referred to as the Equity Style Box, is a nine-square grid that classifies securities by size along the vertical axis and by value and growth characteristics along the horizontal axis.

Little academic research has been conducted that empirically and systematically compares the two most common approaches to assessing a mutual fund’s investment style, i.e., portfolio-based (fundamental) style analysis and returns-based style analysis. Ea

This paper examines the role that style (growth vs. value) plays in the risk and return characteristics of equities. Ibbotson Associates, with the help of the Center for Research in Security Prices (CRSP®), has created a set of style indices going back t

The Morningstar Rating™ for separate accounts is a quantitative assessment of past performance--both return and risk--as measured from 1 to 5 stars. The Morningstar Rating, often referred to as the "star rating," is a familiar tool that helps investors e

Morningstar calculates gross returns for funds as a simulation of the returns investors would have received had they not paid any expenses. Here are the formulas.

There are two main approaches to style analysis: holdings-based and returns-based. This study compares these methods by (1) developing a method to display the style plot points generated by the two methods, and (2) comparing the style plot points generat

This paper examines the constant and variable liquidity direct real estate price indexes of Fisher, Galtzaff, Geltner, and Haurin [2003] and use them in asset allocation exercises. Review of these indexes suggests they provide improved measures of direct