Rankings of Mutual Fund Performance
Morningstar is known for their mutual fund performance rankings, but does this mean that the average investor should base their choices of which fund to buy on these rankings? A growing number of advisers say that they should not, because the star rating system that Morningstar uses is based on risk-adjusted past performance. This can be useful information, but it does not necessarily predict the future.
Index funds may be a better choice for many investors then trying to pick tomorrow's winning active managers. Morningstar concedes that its system is not perfect, but the company argues that the stars provide useful guidance. They are conducting new research analyzing the performance of their ranking system and also looking at Sharpe ratios and other measures of past performance. The goal is to determine whether using combinations of indicators can result in more reliable predictions of future performance.