Mutual Fund Ratings – a Critical Analysis: Are Mutual Fund Ratings a Valuable Service for Investors?

Kristina Roider

Student thesis: Master thesis

Abstract

Looking at today’s investment market, we find an increasing number and complexity of mutual funds. Helping investors to cope with the investment decision, the mutual fund rating industry blossomed. Mutual fund ratings’ influence is so high that researchers claim the ratings have impact on the in- and outflows and even the market share of the asset management industry. Based on the rise and the high influence of mutual fund ratings, this study examines the value of mutual fund ratings for individual investors in Germany. The analysis is based on several different aspects of value. As ratings have a high influence on the fund flows it is necessary to ask whether fund ratings have predictive power for future fund returns. However, some raters claim that their rating should rather be used as a performance achievement score and only offers information value of past fund features for the investor. In order to answer both aspects, the analysis is divided into two parts. From the first part of the analysis is found that the most important raters in Germany, Morningstar, Lipper and Feri employ different rating methodologies. Several components of mutual fund ratings that influence the quality of mutual fund ratings are outlined, before the three raters get evaluated based on these components. Each rating provider shows advantages and limitations in its ratings that have an influence on the quality assessment of the fund and therefore on the offered value for the individual investor. Detailed information about the fund is hidden from the investor in the complex rating methodology that produces one single rating score. This assessment of fund quality in one number communicates a relationship between rating and fund performance in the same way as credit ratings. This link therefore had to be analyzed in the empirical part of this study. The empirical part of this thesis therefore tests the predictive power of mutual fund ratings from Morningstar and Feri for future return for the German fund universe from 2000 to 2011. This analysis is based on the most important study by Blake and Morey (2000). Results on this study indicate little predictive power for the Morningstar rating and no predictive power for the Feri rating. Fund ratings offer little or no predictive power for future return in the mutual fund ratings and the complex process of fund evaluation also limits the offered information to the investor. The conclusion of this analysis is therefore that mutual fund ratings offer limited value to the individual investor in Germany.

EducationsMSc in Finance and Strategic Management, (Graduate Programme) Final Thesis
LanguageEnglish
Publication date2012
Number of pages106