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Report Criticizes Morningstar’s Star-Rating System, Industry Influence

The Wall Street Journal in an expansive report took aim at Morningstar’s star rating system and potential conflicts in the research firm’s business. The article contends that the star rating system, while marketed as a guide to a fund’s future performance, is backward looking and not a reliable indicator of future performance. The WSJ analysis found, among other things, that of funds awarded a five-star overall rating, only 12% performed well enough over the following five years to earn a top rating for that period and 10% performed so poorly they received a one-star rating. Morningstar responded with a statement from its CEO that acknowledged Morningstar’s market influence and stated that the star rating system is meant to be only a starting point for research. In other analysis, Morningstar pointed out that the WSJ’s numbers actually highlighted the efficacy of the star rating system because the numbers indicated that picking a higher-rated fund leads to better future results overall. The head of global manager research for Morningstar wrote that while the star rating system has limitations given its reliance on past performance, it can be a useful starting point for fund research and may point investors toward cheaper funds that are easier to own and likelier to outperform in the future.