Most people who are investing in mutual funds are not mutual funds analysts. They perhaps would be unaware of what a Sharpe ratio is or why one provider will charge basis points for Fund XYZ and some others will be charging only 25 basis points for Fund ABC. A great number of investors are not trained in Fundamental Analysis and perhaps they would not be knowing how to read a candlestick share chart. What an investor is looking for when investing is a relatively safe place to save their money and hoping to earn a good return along the way.
Companies like Lipper and Morningstar are mostly responsible for evaluating funds, highlighting critical data, and awarding a simple, easily comparable rating to each of them. Mutual fund companies are critical of their Morningstar and Lipper ratings as they know very well that most of the investors and financial advisors rely on them to make important investment decisions.
Lipper on the other hand uses five separate quintiles or categories. It rates each fund with five different measures. Both Morningstar and Lipper ratings are published widely. People find them very accurate. Understanding the strengths and weaknesses of each of the rating system would be a better approach. In , the first of the Morningstar rating was introduced. It mainly concentrated on a few brand categories and was more of an accumulation resource of data than a comprehensive evaluation.
This system was overhauled in Categories of the new fund were incorporated, and groups were structured to emphasize differences other than management styles. New metrics were included in it and it broke performance history into various time periods. Fund directors may be faced with the choice of using Lipper classifications or Morningstar categories in the 15 c reports for funds they oversee. This document highlights the basic similarities and differences between the two systems for classifying mutual funds.
It is not meant to recommend one system over the other; in fact, we anticipate that some clients will use one system for a set of their funds and the other system for the rest. The two systems are universal — covering all funds, including open-end, variable annuity portfolios, and exchange-traded funds ETFs — and exclusive: a fund can be in only one group. Note that Morningstar has a separate system for closed-end funds and Lipper has some unique classifications for both insurance and closed-end funds.
For diversified equity funds, both firms parse portfolio holdings to determine style value, core, or blend and market capitalization large-cap, mid-cap, and small-cap. Additionally for US diversified equity products Lipper has both multi-cap and equity income groupings.
Morningstar also relies on a similar portfolio analysis to categorize multi asset and allocation funds, as well as specialized equity funds. To determine average credit quality and duration, Morningstar currently relies on survey data voluntarily provided — or not — by the fund manager, but plans to parse bond portfolios by analyzing individual holdings, as it does now with equity funds. Both Lipper and Morningstar group funds based on their holdings for the past three years.
Lipper assigns a higher weighting to more recent portfolios; Morningstar equally weights each portfolio. The two systems are largely automated, though there is some oversight by investment analysts, and fund managers may appeal their assignments.
Finally, both Lipper and Morningstar have ratings — Lipper Leaders and the Morningstar star rating — as well as benchmarks, based on their respective systems. As noted, both Lipper and Morningstar group funds based on their holdings for the past three years. Morningstar categories are tied to a schematic, the style box for equity, fixed-income, and more recently, alternative funds; Lipper does not have such a schematic.
One element of the Lipper Leaders rating is cost; price is an element of the Morningstar medalist ratings, but not the star rating. Last, Morningstar offers qualitative commentary based on its category system; Lipper does not itself analyze funds based on its classification system.
Most significantly, for each group, Lipper has an equity income classification; Morningstar does not. And, for each of the style-based columns, Lipper has a multi-cap classification; Morningstar has only single market capitalization categories.
For regional equity funds, Lipper and Morningstar have virtually identical groupings, though the members of each grouping do not overlap entirely. For equity as opposed to commodity energy and natural resources funds, Lipper has three classifications whereas Morningstar has two. For equity sector funds, the two firms again overlap almost entirely, with groupings for funds that focus on MLPs, industrials, precious metal miners and producers, communications stocks, and utilities.
In three areas Lipper has both a global and a domestic classification whereas Morningstar has but a single category: financial services, technology, and healthcare. Lipper separates consumer goods and consumer services funds; Morningstar divides between consumer defensive and consumer cyclical funds.
Both firms have a grouping for infrastructure funds. Morningstar has four duration-based categories: ultra-short, short, intermediate, and long. For US government bond funds, Lipper has two Treasury bond classifications, short and general long. Morningstar groups Treasury-focused funds under its government categories.
Morningstar has three government bond category types: short, intermediate, and long. Both Lipper and Morningstar have an inflation protected bond grouping. Neither firm has a distinct grouping for non-US inflation-linked bond funds, or for real return funds.
Morningstar has a single corporate bond category. And, Lipper has a Convertible Securities classification which overlaps with the Morningstar Convertibles category. Morningstar and Lipper are the biggest players when it comes to tracking mutual fund performance.
Their rating systems and performance rankings are widely used in the industry. For instance, the same mutual fund can be classified differently depending on the research firm. In the fund finished down 62 percent. When the market rebounded last year, Encompass surged percent — topping more than funds in its category.
Lipper gives Encompass a top-notch 5 in two categories, and 4, 3 and 1 in the others. One reason for the differences: Morningstar categorizes Encompass as a world stock fund.
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