Box Jumping: Portfolio Recompositions to Achieve Higher Morningstar Ratings

56 Pages Posted: 15 Oct 2024 Last revised: 4 Nov 2024

See all articles by Lauren Cohen

Lauren Cohen

Harvard University - Business School (HBS); National Bureau of Economic Research (NBER)

David S. Kim

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Eric C. So

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Date Written: September 29, 2024

Abstract

We show a novel mechanism by which mutual fund managers strategically alter their portfolios to take advantage of investors’ reliance on Morningstar star ratings. Specifically, funds achieve higher ratings by changing their holdings to induce Morningstar to reclassify them into size/value style boxes with lower average performance, thereby enabling more favorable peer comparison. This practice, which we term ‘box jumping’, attracts fund flows and higher fees, despite sacrificing return performance and the ratings upgrades reversing within three years on average. These patterns emerge after 2002 when Morningstar ratings began to be based on relative performance within style boxes, and are predictably absent beforehand. We also show that pervasive box jumping creates negative spillover effects on other funds. Together, our findings highlight portfolio recomposition as a novel and strategic lever that funds use to manipulate Morningstar ratings, and that funds box jump despite compromising returns due to investors’ fixation on ratings when allocating capital.

Keywords: Strategic Behavior, Mutual Fund Benchmarks, Performance Management, Investor Protection, Morningstar

Suggested Citation

Cohen, Lauren and Kim, David and So, Eric C., Box Jumping: Portfolio Recompositions to Achieve Higher Morningstar Ratings (September 29, 2024). Available at SSRN: https://ssrn.com/abstract=4971228 or http://dx.doi.org/10.2139/ssrn.4971228

Lauren Cohen

Harvard University - Business School (HBS) ( email )

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HOME PAGE: http://www.people.hbs.edu/lcohen

National Bureau of Economic Research (NBER) ( email )

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David Kim (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

Eric C. So

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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E62-416
Cambridge, MA 02142
United States

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