A recent Pensions&Investments column urges defined contribution plan sponsors and consultants to use caution when selecting mutual funds based on their ratings. The author argues that most ratings are based on past performance which are not effective forward-looking measures. Although past performance is not predictive of future results, the data can still provide useful information:
“Past performance can be one indication of a well-managed fund. In addition, a rating system can be used as a first filter when developing an overall investment strategy. For example, the rating system could be used as an introduction to prospective funds — but not the deciding factor or the only factor to use when researching and selecting a mutual fund.”
He encourages sponsors to use qualitative factors when selecting funds for their investment menus, rather than solely relying on quantitative-based ratings. Qualitative factors to consider include a thorough analysis of the fund’s organization, management, investment style, philosophy and process.