The Ranking Properties of the Morningstar Risk-Adjusted Rating

Abstract

The study examines the ranking properties of the Morningstar risk-adjusted rating (RAR). We find that the RAR and the excess return from the CAPM regression yield similar star ratings. In contrast, we document systematic differences between the star ratings produced by the RAR and the excess return estimated from the Fama-French [1993] three factor model. Approximately 77% of domestic equity funds with a ten-year five-star Morningstar rating do not maintain their five stars under the null hypothesis of the Fama-French three factor model. The study concludes that the sole reliance upon the Morningstar star rating to select U.S. equity funds may not result in an optimal allocation across style categories for a multi-fund portfolio.

Keywords: Morningstar, Fund Rating

JEL Classification: G11