High Morningstar Rating Significantly Increases Fund Flows, Firm Finds

An analysis of Morningstar’s Star Ratings’ and future fund flows by research firm Flowspring finds that the ratings significantly influence investors and the movement of “billions of dollars of capital each month.” According to the paper, which was also reported on in the Financial Times, the average 5-Star rating from Morningstar is worth $229,000 in new fees and even higher gains can be seen for some funds: “The largest value for a 5-Star Rating is roughly $28 million for a fund share class that manages $95 billion at a 0.75% expense ratio – this fund currently is assigned 4-Stars.” Funds at the very top or bottom of the ratings scale tend to be most benefited or penalized by the ratings system. “Clearly, investors are concerned with putting themselves in the best performing funds and avoiding the worst performers, but less effort is expended differentiating between middling funds,” Flowspring says. Among other findings from Flowspring:

• More than half a trillion dollars in gross flows were directly attributable to the Morningstar Star Rating system in 2017.
• There are huge benefits to having 5-Stars and even greater penalties for having 1-Star, but very little differential among 2-, 3-, and 4-Stars.
• After a 1-year time horizon, 60% of share classes have the same Star Rating and 96% have changed by 1 Star or less.