What is Morningstar?

Founded by Joe Mansueto in Chicago, USA, Morningstar was launched with the introduction of the Mutual Fund Sourcebook in 1984. Mutual funds were established to give individual investors access to the same benefits enjoyed by wealthier investors, ie a large asset base, a diversified portfolio, and professional management.

Joe Mansueto therefore believed that data and information on these investments should be widely available. Over the years, that simple philosophy has led Morningstar to create a wide selection of products and services for both individuals as well as institutional clients.

An international expansion has established Morningstar operations throughout Asia and Scandinavia. Morningstar Europe was set up in 2000 with headquarters in London and local offices in Amsterdam, Madrid, Milan, Munich and Paris.

The Morningstar Europe Rating provides an easy-to-use ranking of the returns of comparable funds, taking into account costs and risk. The key ingredients of the Morningstar Rating are:

• Morningstar Categories
• Costs inputs
• A risk-adjusted return calculation.

Morningstar Categories

Morningstar Categories bring together funds that have genuinely similar investment policies, as reflected by their portfolio holdings. Morningstar devotes significant effort to the collection and analysis of complete portfolios to meet this demanding objective.

Stated investment objectives and fund names are often not a sufficient basis for the reliable allocation of funds to categories. The relevant parameters are a fund’s investments in particular equity markets, in bonds markets or in a combination of both. In the UK, the key Morningstar Categories are:

• UK Equity Large Cap
• UK Equity Mid Cap
• UK Equity Small Cap
• Europe ex UK Equity
• Europe ex UK Small Cap Equity
• Europe Large Cap Equity
• Europe Small Cap Equity
• Euroland Large Cap Equity
• North America Equity
• North America Small Cap Equity
• Asia Equity
• Asia ex-Japan equity
• Japan Equity
• Japan Small Cap Equity
• Global Equity
• World ex UK Equity
• Global Emerging Markets Equity
• Latin America Equity
• TMT Sector Equity
• Other Sectors Equity
• Sterling Balanced
• Sterling Bond
• Sterling Government Bond
• Sterling High Yield Bond
• Sterling Global Bond
• Sterling Short Bond
• Sterling Money Market
• Emerging Market Bond

Costs

All annual expenses incurred by a fund are already deducted from the raw performance figures. Additionally, the Morningstar rating systematically takes initial charges into account. Any equity or balanced fund will receive a 5% charge, unless of course the maximum charge applicable is lower, in which case that maximum initial charge is applied in the calculation.

For bond funds, the charge is 3% unless the maximum initial charge happens to be lower. There is a trade-off between initial charges and annual charges, and Morningstar endeavours to assess all funds on a level playing field over the relevant measurement period.

Risk-Adjusted Returns

For all rated funds, we use three years of return data. Whilst we are well aware that the past volatility of those returns is not a perfect description of fund risk (hence our focus on complete portfolio holdings), we are making the best possible use of the available data.

Our calculation is based on a representation of the utility that the investor derives from the fund's returns. Investors prefer to receive returns in a regular fashion rather than in fits and starts: in other words, they are averse to risk. Our formulation reflects the fact that, the more consistent the returns through time, the better.

The Stars

Once these calculations have been performed, funds can be ranked in their categories.

The stars are allocated as follows:

• Top  10% 
• Next 22.5% 
• Middle 35% 
• Next 22.5% 
• Bottom 10% 

These calculations are performed every month and therefore can fluctuate, much like the relative performance of any given fund can fluctuate.