The 5 star funds rating is a quick way to gauge whether a fund has added value over time on a risk adjusted basis. The 5 star funds rating should only be one of many factors considered by investors when evaluating and selecting funds for investment. The 5 star fundsrating is objective, based entirely on a mathematical evaluation of past performance. The 5 star funds rating is a useful tool for identifying 5 star fundsworthy of further research but should not be considered buy or sell recommendations.
In June 2002, Morningstar revised its rating methodology for determining 5 star funds and below. The universe of mutual funds was segregated into 48 categories instead of four broad asset class categories and 5 star funds are now a subset of those 48 categories. Morningstar did this to facilitate the comparison of 5 star funds against more relevant peer groups so funds would become 5 star funds when their managers added value rather than when their category performed well. Morningstar also sought to incorporate the risks of 5 star funds in the 5 star funds rating calculation so it adopted a utility function of risk measure that identifies 5 star funds based on volatility. Additionally, the risk measure of 5 star funds is more heavily weighted relative to the returns of 5 star funds in the 5 star funds rating calculation. As a result, 5 star funds typically have managers who have added value, 5 star funds tend to be less volatile, and 5 star funds usually have fewer risks.
For more information regarding Morningstar ratings for 5 star funds, please visit http://quicktake.morningstar.com/DataDefs/CEFRatings.html.
On December 8, 2009, Advisor Perspectives published an article titled "Morningstar Ratings Fail over a Full Market Cycle." Using data for the three years ending September 30, 2009, Advisor Perspectives found that Morningstar's ratings lost virtually all of their predictive ability when measured over a full market cycle.
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