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Morningstar jumpstarts its star rating system with favorable self-review yet audit finds it misses the mark in bear markets, supporting claim of dubious predictive value cited by Wall Street Journal

The Chicago-based tracker assures investors that its ratings tilt odds in their favor though critics say it's more a gauge of momentum than scientific research.

Author Oisin Breen August 31, 2022 at 5:08 AM
no description available
Jeffrey Ptak: The star rating seems to tip the odds in the investor’s favor.'

Brian Murphy

Brian Murphy

September 6, 2022 — 4:27 AM
Agree with the main points of the article. Any rating system based purely on historical data is going to falter when the market shifts direction...moving into either a bear, or bull, market. There is a rather simple way to handle this however that I haven't seen tried - and that has to do with the diversification within a given fund and the over/underweights to various sectors. One could forecast a fund's risk in a market disruption by using a "downside" covariance matrix approach by assuming something simple like a) all sector correlations move towards 1, and b) beta of individual assets within the fund increase by say 50%. Run a the fund's exposures through this "downside" covariance matrix and you've got a bear market estimate. Then, based on how over, or under, valued the market is you can forecast a probability of market downside risk occurring at any time. Use this as a Bayesian adjustment to Morningstar's standard approach. Maybe the folks at M'star have already played around with this and I'm just unaware, but seems a more robust approach than what's "state of the art" today.

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Mentioned in this article:

Morningstar, Inc.
Top Executive: Joe Mansueto

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