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.

Long-term U.S. open-end funds and exchange-traded funds had $22.1 billion in outflows, their greatest outflows since August 2015

The Market-Driven Scenario Analysis tool allows users to select a market index and to specify the percentile dividing the range of the return distribution to determine the impact of user-specified market shocks on factor exposures, portfolio returns, and Value at Risk.

This paper seeks to outline the methodology Morningstar uses in calculating the expected future yield as of the portfolio date, from the holdings of the portfolio. The measure is based on Forward Dividend Yield (forward-yield) for stocks and the yield-to-maturity of the fixed income portfolio.

We agree that there's much to be skeptical of with the original robo-advisor business model. In fact, we wrote in 2015 about the challenging economics, how many stand-alone robo-advisors wouldn't survive, and robo-advisors integrated with established financial institutions would leapfrog the early leaders. However, new business models are addressing the three faults of the original robo-advisor model: high client acquisition costs, ongoing costs of servicing clients, and low revenue yield on client assets. Lead-generation tools and strategic partnerships are reducing acquisition costs, while building for scale and operating leverage eventually solves service costs. Revenue-enhancement strategies underpin much of our optimism for select robo-advisors becoming profitable. Upselling to human advice, ancillary service offerings, and incorporating proprietary products in portfolios are key revenue drivers. We don't see robo-advisors disrupting moaty financial institutions. Instead, we expect established financial institutions will co-opt the technology and user experience improvements of robo-advisors to expand their own businesses. Among the asset management, wealth management, and online brokerage firms that we cover, we believe Invesco, Credit Suisse, and UBS are trading at the most attractive valuations.

U.S. Equity Inflows Surge, While International-Equity and Taxable-Bond Flows Tail Off

Morningstar's cross-listed ETP performance methodology.

Here is the methodology for this designation, which is assigned to portfolios that have low carbon-risk scores and low levels of fossil-fuel exposure.

Fiduciary responsibility and increased regulations require investors to analyze and understand their risk exposures in a carbon-constrained future. To help investors address this challenge, Morningstar has introduced portfolio carbon metrics that measure the risk that companies in a portfolio face from the transition to a low-carbon economy.

Methodology paper explaining how Morningstar calculates the average bond price for a portfolio.

Morningstar ETF Managed Portfolios Landscape Report Q4 2017

Profit margins have expanded rapidly over the past three decades. That, combined with strong optimism for future growth, has driven market earnings multiples to extreme levels. We view overall stock market valuations as stretched, with close to 60% of our universe trading above our fair value estimates as of October 2017. While we do expect a partial reversion to the historical valuations of the past as economic pressures build, the durability and defensibility of the largest firms’ competitive positions suggest that profitability levels will not fully revert to historical midcycle levels.

All-time high flows, paired with positive returns, lifted assets in target-date mutual funds above $1 trillion in 2017. This year's report covers recent developments in the competitive landscape, and then it highlights noteworthy considerations for target-date investors in five areas: Price, Performance, Parent, People, and Process.

U.S. President Donald Trump recently shook up global financial markets by announcing plans to enact import tariffs of 25% on steel and 10% on aluminum. The exact form these tariffs will take remains unclear. We've updated our forecasts and fair value estimates based on the expectation of a targeted approach. A blanket tariff covering all imports would be far more severe and, in turn, far more beneficial to U.S. steel and aluminum producers. The consequences for U.S. metal users, while significant in aggregate, are far more diffuse, impacting industries from aerospace to aluminum cans. Accordingly, our long-term forecasts and fair value estimates for these companies aren't meaningfully affected. Harmful second order effects, including retaliation by U.S. trade partners, are possible, but we have not assumed major moves in our base case forecasts. Perhaps the most damaging of potential reactions would be cancellation of significant Boeing aircraft orders by Chinese customers.

The paper outlines category definitions applicable to the New Zealand market.

The paper outlines category definitions applicable to the Mexican market

New Year, Not-So-New Trends in Flows

To receive safe harbor regulatory protections, defined-contribution plan sponsors must, among other things, follow a prudent process for selecting a qualified default investment alternative. This includes considering the specific demographics of the participants when making a QDIA selection. Unfortunately, regulations do not provide much of a blueprint on how to consider demographics. This paper presents a framework for using participant data to help determine which type of QDIA may be most appropriate, including which glide path best fits the demographics of plan participants, when a custom glide path may make sense, what the “pivot” age should be for a hybrid QDIA, and when managed accounts may be necessary for meeting the unique needs of a plan.

This methodology addresses the assumptions and formulas used in calculating the Total Return. This methodology is only applicable to interest rate series that are updated at a daily frequency. It is intended for interest rate indices with one or less years to maturity.

Taxable bond was once again the Morningstar category group with the largest inflows last month, as investors sought to lock in the gains of an almost-nine-year bull market and continued to rebalance from stocks to bonds.

We draw on results from a survey of U.S. adults to create a model of financial health. Using demographic, psychographic, emotional, and behavioral variables, we show that financial behavior and emotional well-being are affected by two simple mental factors that advisors can target to better help their clients achieve financial health.

An $8.7 billion inflow is impressive for a category group that’s usually in outflow territory. Investors poured $27.6 billion into passive U.S.-equity funds last month, more than doubling the previous month’s $12.7-billion inflow. U.S. GDP growth has been at around 3.0% for two quarters in a row, and Washington has recently been focused on passing a tax bill that would significantly reduce corporate tax rates and make it easier for businesses to increase profitability.

Despite expectations of rising rates, taxable bond was once again the most popular category group in September with $34.9 billion in flows overall, significantly higher than the $27.5 billion it had received in August. In a reversal from the previous month, passive taxable-bond flows surpassed active ones: $20.5 billion versus $14.4 billion.

Taxable bond remained the leading category group in August with $27.5 billion in flows overall. Unlike in June and July, however, active taxable-bond flows surpassed passive ones: $14.1 billion versus $13.3 billion.

Morningstar category averages are designed to represent the average return of funds within their category over time. Morningstar creates a category average daily total return index series, or TRI, as well as monthly, quarterly, and annual averages of return and non-return data.

This document details the methodology for the Morningstar Total Return Index, calculated at the fund level and representing the value over time of one share purchased and owned since inception, assuming all dividends and distributions are reinvested.

Morningstar Risk Model Performance Attribution Methodology

Far from experiencing a slowdown, taxable bond and international equity saw a lot of activity in July. The two Morningstar category groups attracted $34.7 billion and $23.0 billion, respectively. For both, the majority of these flows came from passive funds. Active flows, in the meantime, remained positive and considerable in size.

Morningstar and Sustainalytics partner to analyze the pros and cons of nuclear power as an ESG investment.

Taxable Bond and International Equity Continue to Dominate Flows Investors continued to stream money into taxable-bond and international-equity funds in June. Unlike in previous months, the taxable-bond Morningstar category group saw higher inflows on the passive front than on the active one, although active flows still remained substantial at $14.4 billion.

After five encouraging months and a so-and-so April, the U.S. equity category group slid into outflow territory in May, with total redemptions of $3.1 billion. Taxable bond remained the overall leader with inflows of $36.9 billion, and international equity came in a close second, attracting $35.7 billion.

The Morningstar Portfolio Product Involvement metrics measure a portfolio’s exposure to involvement in a range of products, services, and business activities. The metrics are holdings-based calculations that use company-level analytics from Sustainalytics, a leading ESG research provider. The metrics are calculated for managed products globally using Morningstar’s portfolio holdings database.

Introduction to Morningstar fixed-income calculations.

For investment portfolios that hold meaningful levels of fixed-income holdings, Morningstar produces a number of calculated fixed-income analytic measures. Portfolio analytic measures are created by first calculating corresponding holding-level measures and then aggregating the values to a portfolio level through a process known as holding-based analytics.

To provide fixed-income investors with meaningful information about the credit risk in managed investment portfolios, Morningstar calculates a holding-weighted measure of exposure measured by credit-rating categories called the Credit-Rating Breakdown.

For managed investments such as mutual funds, Morningstar calculates average effective maturity. This measure is the holding-weighted average of the terms of the individual instruments within the portfolio. With this measure, investors can analyze exposure to interest-rate risks and reinvestment risks as well as estimate whether an investment aligns with future liability needs.

Fixed-income analysis is inherently an exercise in the measurement of future cash flows. Payments of interest on principal invested constitute the primary means of return to fixed-income investors with the expectation that the principal will be repaid upon maturity. Therefore, measuring the expected rate of return and potential risks to these payments is of paramount importance.

The Global Risk Model helps you identify and assess the amount of risk in your investments.

After four months during which U.S. and international-equity funds attracted similar inflows, international equity took the lead in the equity space with a little over $21 billion in total flows. U.S. equity's winning streak seems to have waned, as the category group received only a meager $280 million in April 2017.

Morningstar Category classifications sorts portfolios into peer groups based on their holdings. The categories help investors identify the top performing funds, assess potential risk, and build well-diversified portfolios. Here is how those categories are decided upon and funds assigned to them.

Morningstar Europe, Asia and South Africa Category definitions for managed investment portfolios

Morningstar U.S. Category definitions for managed investment portfolios

Some Flows Are Going Into Equity, but Fixed Income Is Still in the Lead Taxable-bond funds attracted the highest inflows once again in March, even higher than they had in February. The flow this month was almost evenly distributed between active and passive taxable-bond funds, underlining that in fixed income, as opposed to equity, active management is still very much alive.

The Morningstar Style Box™ was introduced in 1992 to help investors and advisors determine the investment style of a fund. It provides an intuitive visual representation of style that helps investors build better portfolios and monitor them more precisely.

This methodology describes Morningstar’s approach to issuing letter-grade ratings for commercial mortgage-backed securities at issuance and during surveillance.

Bonds Still in Favor, With U.S. Equity Close Behind Taxable-bond funds remained the undisputed favorites in February, attracting $35.5 billion in estimated net flows. U.S. equity funds, however, received double the flows they had taken in the previous month.

Any new beginning is uncertain, and this held true for markets in the first month of 2017. The new president’s promises of tax cuts and infrastructure spending appeared to spur newfound confidence in U.S. equities late last year, driving flows into U.S.-equity funds in November and December. January, however, saw a much smaller amount stream into U.S.-equity funds, and the majority of the flows redirected to fixed-income and international-equity funds.

U.S. investors favored passive funds over active by a record margin in 2016.

Morningstar data point explanation.

If you help your clients raise financially fit kids, everyone wins: Your clients get peace of mind that their children will be better equipped for life on their own, the children get a financial head start to prepare them for financial independence, and your practice benefits from stronger client relationships and, potentially, a new generation of clients. Our new paper examines: Why learning by example isn’t enough to prepare kids for financial independence. Simple rules of thumb that advisors can encourage their clients to use when teaching their children about money and why parents should be more transparent with their children about their money situation.

Helping your clients navigate personal relationships might not be your favorite talking point, but your willingness to tackle the issue head-on could be key for your business. Our paper, Financial Turning Points: Relationships, Marriage, and Divorce, examines: How prenuptial agreements and “freedom funds” should be seen as romantic, rather than restricting. How advisors can help their clients learn to argue productively—and why they should. Why tracing financial behavior back to underlying needs is important when married clients have different attitudes about money. How advisors can help clients cope with post-divorce financial reality.