What Should Investors Care About? Mutual Fund Ratings by Analysts vs. Machine Learning Technique

Abstract

We examine two forward-looking mutual fund ratings provided by Morningstar: the analyst rating produced by human analysts and the quantitative rating generated by machine learning technique. The analyst rating identifies outperforming funds, while the quantitative rating fails to do so—such a difference is mostly due to the selection of analyst coverage. Moreover, the tone in the analyst report contains incremental soft information in predicting fund performance. Finally, retail investors do not follow analyst recommendations, but instead chase the quantitative rating. The overall evidence highlights the importance of mutual fund analysts in information production and implies a capital misallocation problem in mutual fund investment.

Keywords: Analyst Rating, Quantitative Rating, Mutual Funds, Information Provision, Fund Flows, Machine Learning

JEL Classification: G11, G23