I attended Morningstar’s online conference for individual investors a little over a week ago. To be honest, I was disappointed. It made me question whether Morningstar is losing relevance to individual investors in an indexing world.
If investing is like fantasy sports — you assemble a team of players and you compete with others who also assemble a team of players — you need information on the players. You look at stats. You follow the latest development on who’s doing well, who’s not doing so well, and who got injured. Things are always in flux. You check in frequently.
Some people still do this with individual stocks. When I go to the library I sometimes still see people study the Value Line binder or read Investor’s Business Daily. There’s no dearth of information or comments on individual companies on business channels on TV. Online brokers supply research reports that automatically spit out quarterly and annual revenue, EBIDA, cash flow, P/E ratio, and everything you care or don’t care about any company. Morningstar rates stocks on economic moat and it gives a fair value estimate to many stocks.
Individual investors soon realized whatever information they gather, it would be too late by the time it reached them. It’s difficult to compete with full time portfolio managers, analysts, and powerful computers. So they buy mutual funds and delegate the picking job to experienced managers and analysts.
Individual investors always hear it’s a stock picker’s market. It follows that it must be important to have the right pickers. That’s where Morningstar comes in. Morningstar reports data on mutual funds and rates them. It gives star ratings based on performance and it gives medal ratings based on its multi-faceted forward-looking evaluation of a fund’s process, performance, people, parent, and price.
That’s very valuable if we are still in the fantasy sports world. I have all the respect for the hard work Morningstar is doing there.
After 40 years, Jack Bogle’s indexing message slowly settles in. Morningstar reported that in 2014 actively managed equity funds had $98 billion net outflows while passive equity funds had $166 billion net inflows, with Vanguard as the lead beneficiary of the inflows.
In an indexing world, do you still need Morningstar as much?
When you are buying an index fund, you care primarily about two things: the expense ratio, and how closely the fund tracks the index. That’s all. You don’t care about this manager or that manager employing this strategy or that strategy under this economic condition or that economic condition.
What if this Vanguard index fund is rated Silver, not Gold? It’s an index fund. It’ll do pretty much what the index does whether it’s rated Bronze, Silver, or Gold. Will the gold-rated fund beat the index fund? Possibly, but if I’m not in the fantasy sports league should I care?
The Morningstar conference still played to the fantasy sports league world. Panelists rattled off names of their favorite funds and fund managers. No doubt many of those funds beat their index fund benchmarks in the past 1, 3, 5, 10 years or longer. Should I be tempted to think that they will continue beating the benchmark? If the answer is yes, then I should research them on Morningstar. If the answer is no, then the information is not relevant to me.
By settling on indexing, I give up the dream of beating the market. I choose not to play in the fantasy sports league. I take whatever the market gives to me, no more, no less. I fully acknowledge and accept that index funds won’t be the best in any 1-, 3-, 5-, or 10-year period. It’s a fact that index funds will never be the best. It’s a different game with different rules.
I realized I don’t go to Morningstar often these days. I still use its Portfolio X-Ray tool sometimes. That’s about it.
Do you still play the fantasy sports game when you invest? Is Morningstar losing relevance to you?
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Money Beagle says
I used to use Morningstar ratings heavily about 10 years ago, but they always seemed basically a summary of what had happened, not a reliable predictor of future performance at all, at least from my experience. I also rely heavily on management fee data, as I don’t think fees should wipe out high percentages of gains. Funds who do this should receive a lower rating, in my opinion, but since they don’t, I consider it somewhat bad data.
GMShedd says
Actually, I have seen M* give fee-waived versions of funds higher ratings than the loaded versions, so I think they do consider fees in the rankings based on total return. For example, I just looked at the funds that come up when I searched American Funds on M* and found that AADTX.LW (Target Date 2025) gets 5 stars, whereas loaded AADTX gets only 4.
Ryan says
Morningstar publishes the methodology they use for generating star ratings, it is purely based on performance. They weigh the past 1, 3 and 5 year returns then rank the funds against peers in the same category. They do not consider fees, although lower fee series will perform better and thus have a chance of being ranked higher.
Ironically, most fund performance is mean-reverting over that time period so there are theoretical reasons to believe low ratings will perform better than high ratings.
There is actually a study showing morningstar ratings and future performance here: http://www.vanguard.com/pdf/icrwmf.pdf
Edgar says
I use their X-ray tool, and that’s about all. I see no value in their fund ratings, for all the reasons that you mentioned.
Lynne says
Well, if I lived in an ideal world where I could pick 3 or 4 Vanguard index funds and be done, I wouldn’t need Morningstar.
But although I fund a Roth IRA and have a taxable account, most of my retirement savings go into a 401(k) with 20 less-than-perfect (and frequently changing) fund options. And our HSA has 9 choices, none of them index funds. So I research funds on Morningstar to help me assemble the best portfolio possible from limited choices. And now our company, in its quest to reduce its costs by transferring them to us, is changing both 401(k) and HSA providers. I suspect the completely different funds we haven’t seen yet at our new providers will be no better, but I won’t know for sure until I research them at Morningstar, and figure out my least-bad options. (And yes, I could stop contributing to my 401(k), but after 30 years of working, I’ve got a lot of money in that account to invest as best I can).
I’m also a big fan of Morningstar’s Christine Benz, who I think is the best personal finance writer/editor around. I learn more about investing and retirement financial planning from her than any other writer (or paid financial adviser, for that matter).
Learner says
I am admittedly a novice, but I cannot understand the whole 401k fiasco. It’s exactly as you say… less-than-perfect-options for investing your hard earned dollars.
But… in my opinion… you answer the question at hand perfectly here. What’s your reality? What percentage of people are feeling locked into less-than-perfect options within 401k plans with current employers? What percentage of people don’t even know they are locked in? How many people have old 401k plans that they have never rolled over? I think we’re talking about a fairly large percentage of the investing public here. As long as that is the reality for most, Morning Star’s core offering is relevant because at least it gives some standardized evaluation of these options. At the same time, I have to imagine that more people are becoming wise to the alchemy of “alpha” and that means Mutual Funds (and Morning Star’s traditional offering) are becoming less relevant.
You know what would be great? I think employers should provide a quit/rehire option every 5 years for the sole purpose of letting you roll your 401k into an IRA. Let me quit for a week and offer me my job back with terms that match the benefits earned in my tenure with the company (e.g. vacation, etc.). Right now, I’m sorry to say, employers have a built-in disincentive to loyalty. With every year that I give the company (and therefore stay locked into their 401k options), I give up better investment options and lower fees. There’s a subject for another blog post right there: What’s the loyalty burden? When you figure in marginal return with better options and compounding over time, what’s the penalty you pay for being loyal to a company (and therefore staying locked into their 401k plan)?
$iddhartha says
I have always liked Morningstar as a website, but I take their ratings with a grain of salt. I use the performance feature where you can track the total returns of a $10,000 investment.
I’m almost entirely invested in index funds.
Sam Seattle says
I agree that their online conference last week was a disappointment.
GMShedd says
Good point! Paradigm shifts often happen without being noticed until someone bothers to ask, “Remember when we used to…?” I used to get 3 financial magazines, 2 newsletters, a subscription to Barrons, and pay for an M* account. Now I get 1 magazine and 1 newsletter, and I’ll probably drop the magazine when it comes up for renewal. On the other hand, I recently found this website called “The Finance Buff” where they actually sweat the details to a degree of completeness that is truly admirable!
Sam Seattle says
Yes, The Finance Buff is excellent. What is the 1 newsletter that you subcribe?
KD says
I agree with you that the conference concept was a generation behind the current continuum of personal finance shifts. The delegation & shift of expertise from individual investor to a broker to a robo-adviser/ automated indexing is well on its way.
Going down the line in next few years, robo-advisers will do extremely well after amassing large data to figure to personal and controllable factors influencing the individual decisions and outcomes, like rate of savings, choice of accounts, mapping life events into the “accumulation” and “spending” phases etc.
To digress a little …
Personal finance is still somewhat stuck in its paradigm of continuous accumulation followed by continuous spending of that accumulated pot. As the concept of what is employment, what is a job, and what is a career changes in coming years, so will people’s perspective of what can they reasonably control. Current personal finance is somewhat stockholm-syndromed by “ultra-conservatives” who want to save up 25x or 33x spending and do not want to work ever again. More meaningful discourse would be what are personal triggers to give up a a career that pays to a career that develops to your needs and pace. How to determine the need of putting in time, money and effort for a career that pays well in medium term that will enable to shift to a career that offers more self-fulfillment. Thus offering medium term financial security to take risks over a permanent lifetime financial security. I fill that folks who have the ability to plan “FIRE” so to speak certainly would have desirable and employable skills that may be called upon to buttress the financial security as needed. Why grind at it for that marginal security to not have to work again? Wouldn’t a healthier paradigm be to find a balance? May be I like to work more that folks who want to FIRE …LOL!
JohnInIowa says
Harry, do you have any thoughts about bond funds?
It was my impression that the bond market is less efficient than the stock market. If that’s so, then an actively managed bond fund might have a better chance of bettering a passive fund than is the case for stocks. But I haven’t seen statistics comparing active vs. passive bond funds in aggregate.
Harry Sit says
JohnInIowa – Statistics are not good for actively managed bond funds due to their higher cost and less upside in bonds to begin with. See Vanguard short video Does index fund investing work for bonds? However, I believe it’s a story more about low cost than about indexing per se. The Vanguard bond fund I invest in is technically actively managed but it has very low expenses, holds a large number of bonds, and it doesn’t trade much. Of course the Morningstar favorites such as Metropolitan West Total Return and Dodge & Cox Income did beat the Vanguard total bond market index fund. Whether they will continue to do so is always the question.
Mark Zoril says
Glad you wrote this. I have been wondering more and more about where Morningstar will end up in the future.