Morningstar to shine harsher light on fund fees

The ratings firm is preparing to ‘set a higher bar’ for active managers

Morningstar to shine harsher light on fund fees

The importance of cost has been broadly underscored throughout the investment industry, as confirmed by a Morningstar report showing the majority of assets going to the lowest of the low-fee funds in 2018. With that in mind, the ratings firm is set to prioritize costs more in its evaluations of investment products.

ThinkAdvisor has reported that Morningstar is preparing to focus more on costs in the fourth quarter, as per a note sent to the firm’s clients on Friday. With that course set, some of the 25,000 investment products rated by the firm could see downgrades down the road.

“We’re setting a higher bar for active strategies,” the note from the firm said, adding that it will dispense “fewer Medalist ratings to active strategies in areas where analysis finds there’s less payoff to active investing.”

The medalist ratings, rolled out in 2011, assign funds into gold, silver, bronze, neutral, and negative categories. The ratings overhaul is reportedly going to impact those ratings, but not the star ratings handed out by the firm.

“Morningstar will change the methodology analysts follow, setting a higher bar for funds to earn a Gold, Silver, or Bronze rating and doubling down on fees,” the firm said in its note to clients. “The Analyst Ratings will also be tailored to individual fund share classes, taking fee differences into account.”

Morningstar explained that the new system, set to take effect on October 31, will deduct a strategy’s expenses from analysts’ estimate of the value it can add before fees. With that evaluation, the firm said, there will be “a sense of what value investors will net after fees are taken into account, which is what ultimately matters.”

Currently, fund managers are evaluated based on their ability to outdo either their respective benchmarks or peers “net of fees and accounting for risk.” As of October 31, they must beat both. Different share classes will also be each evaluated for their fees, which raises the possibility of downgrades of those that combine advice and sales fees.

The firm also mentioned changes it is making to its Sustainability Ratings of ESG funds, which it says aim to “provide investors with a greater understanding of the financial vulnerability they face from materially significant ESG risks in their portfolios.”


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