Morningstar Risk Rating Definition Factors Assessed and Example
Morningstar Risk Rating:
The Morningstar risk rating, or Morningstar rating, is a ranking given to publicly traded mutual funds and ETFs by the investment research firm Morningstar. It helps investors identify suitable funds for their portfolios.
Funds receive ratings from 1 to 5, based on variations in their monthly returns compared to similar funds.
Key Takeaways:
– Morningstar risk rating is a ranking given by Morningstar to mutual funds and ETFs.
– The rating ranges from 1 (worst) to 5 (best).
– Morningstar ratings are based on the fund’s historical performance compared to similar funds.
– Critics argue that Morningstar ratings do not consider the overall market.
Understanding the Morningstar Risk Rating:
Morningstar ratings are based on a fund’s past performance compared to others in its category. The rating is not a buy or sell recommendation but serves as a starting point for further research.
In the risk rating process, funds are categorized as low risk, below average risk, average risk, above average risk, or high risk based on their measured risk levels. Risk is measured over three, five, and ten years.
Morningstar also provides category and peer-group ratings for further comparison.
Other Risk Rating Providers:
Morningstar is not the only company that provides risk ratings. Other providers include Thomson Reuters Lipper, Zacks Investment Research, Standard and Poor’s, and TheStreet.
Criticism of Morningstar Risk Ratings:
Morningstar ratings have faced criticism for comparing funds in isolation from the broader market. Some argue that ratings should consider market conditions to assess a fund’s viability and potential.
Example of Morningstar Risk Ratings:
As an example, the iShares Nasdaq Biotechnology ETF (IBB) has an above-average risk rating of three stars based on its performance over three, five, and ten years.
How Do Morningstar’s Star Risk Rating Work?
Morningstar’s star rating measures a fund’s historical risk-adjusted return. Ratings range from 1 to 5, with 5 being the best. Volatility in returns affects a fund’s rating.
What Does a Morningstar Risk Rating of 5 Stars Mean?
A 5-star risk rating indicates that a fund has been a top performer in terms of risk-adjusted return over the past three, five, or ten years.
How Reliable Are Morningstar Ratings?
While star ratings provide a measure of past risk-adjusted return, they do not predict future performance. A study by Vanguard found that Morningstar ratings did not predict profitable investments relative to benchmarks. Interestingly, one-star funds had the greatest excess returns compared to their benchmarks.
