Essentially, Morningstar compares every equity fund against the S&P 500 Index and every bond or fixed-income fund against the Lehman Brothers Aggregate Index. This is a reasonable and uncontroversial indicator of volatility. Morningstar, Inc. (NASDAQ: MORN) first introduced its rating system in 1985. Though investors are likely to receive 10 percent, past variations in the fund's returns suggest that they might end up with anywhere from five to 15 percent. To ensure we apply our methodology consistently across our broad coverage universe, and given the central importance of the economic moat rating to the Morningstar equity research methodology, a committee of 15 senior members of the Morningstar research team oversees all of the individual company ratings. A fund may very well have a five-star rating because of its impressive historical record, but as performance-chasers often find out the hard way, the past doesn't reliably predict future returns. This is a guide only, and is not a recommendation to invest. According to Morningstar, these equities are classified by a review of "annual reports, Form 10-Ks and Morningstar Equity Analyst input.". Even risk and return ratings are made on a relative scale. The information ratio (IR) measures portfolio returns and indicates a portfolio manager's ability to generate excess returns relative to a given benchmark. Fact Sheet: The Morningstar Rating TM for Hedge Funds The Morningstar RatingTM for Hedge Funds is a quantitative assessment of risk-adjusted past performance that grades funds on a scale of 1 to 5 stars. Download Your Copy. Morningstar Quantitative Rating TM for funds Methodology . Morningstar adjusts for risk by calculating a risk penalty for each fund, based on 'expected utility' theory - a commonly-used method of economic analysis. Silver funds have advantages across all of the five pillars. You should come away with a clear understanding of the key issues associated with the strategy, and whether or not it suits your needs. While a higher star rating reflects stronger performance, a high star rating isn't a guarantee that a fund will be a solid performer. The Morningstar RatingTM Methodology| July 26, 2007 © 2007 Morningstar, Inc. All rights reserved. Get to know Morningstar. A measure that takes long-term returns and risk into account is a good first step in a search for 'best-of-breed' managed funds. Morningstar is best known for its star rating system, which assigns a one- to five-star ranking to each fund based on past performance relative to peer funds. 'Role in Portfolio' tells you whether the flagship fund is Core, a Supporting Player, or Satellite holding within the sector under review, and whether you need to blend the strategy with other investment styles and strategies. Morningstar Analyst Ratings are assigned globally on a five point scale, with three positive ratings of Gold, Silver and Bronze, one Neutral rating and one Negative rating. Morningstar assesses the key individuals making the investment decisions, as well as the composition of the investment team, including: In short, how good is the team, and how does it stack up against its peers? The mean is just the average return of the fund. Underlying this rating is a fundamentally focused methodology and a robust, standardized set of procedures and core valuation tools used by Morningstar’s equity analysts. The Sharpe ratio is used to help investors understand the return of an investment compared to its risk. The ratings consist of an easily-identifiable five-star scale, designed to assist you with investment decision-making on funds and fund managers. Morningstar is steeped in modern portfolio theory (MPT), the investment philosophy centered around minimizing risks and maximizing expected returns by strategically diversifying assets. Morningstar Credit Ratings, LLC's bank credit rating methodology is based on the same key components, or pillars, as our methodology for nonfinancial corporations: Business Risk, Bank Solvency Score, Distance to Default, and a Stress Test Score, which is an alogous to the Morningstar® Cash Flow Cushion™ for nonfinancial corporations. The analyst rating is a summary of Morningstar's "conviction in the fund's ability to outperform its peer group and/or relevant benchmark on a risk-adjusted basis.". The company claims that its mutual fund rankings are "objective, based entirely on a mathematical evaluation of past performance." This methodology applies to funds domiciled or available for sale in Europe, Hong Kong, Singapore, Taiwan, and the United States. Some of Morningstar's equity sectors include cyclicals, basic materials, financial services, defensive, utilities, communication services, energy and technology. Morningstar’s Analysis of their New Rating Methodology See our related story analyzing the predictive ability of the Morningstar rating system based on the Morey and Gottesman study.