Morningstar, whose influential ratings are a key driver of flows to asset managers, is shaking up how it grades funds — and many asset managers won’t be happy with the changes, at least according to new research released on Wednesday.
The Chicago research firm is overhauling the way it assigns its widely followed fund analyst ratings, including giving more weight to fees. It found that the rating for roughly 43 percent of its funds, exchange traded funds, and other managed investments will change once its new methodology is in place, according to the new research.
Many of the changes stem from the way Morningstar will evaluate fees and their effect on the overall rating. It will now include all share classes, some of which have high fees to pay for distribution and marketing.
[II Deep Dive: Morningstar Transforms Analyst and Quant Ratings for Funds]
Active funds, already under pressure from index funds, will take another blow under the new system. Morningstar’s research found that the percentage of active managers that get gold, silver, or bronze ratings — its top scores — will fall with the new method. At the same time, the percentage of index funds with top medals will rise.
Fees are the make-or-break factor. Only approximately 26 percent of funds with above-average fees will get a gold, silver, or bronze rating, according to Morningstar. Right now, 50 percent of funds with above-average or high fees boast top-three ratings.
Overall, asset managers are going to have a tougher time getting a fund into the top three categories, according to Morningstar’s report on the impact.
“The distribution of analyst ratings would shift away from gold, silver, and bronze ratings and toward neutral and negative ratings under the updated methodology,” the report said. “Around 1,000 more share classes would receive neutral and negative ratings compared with today.”
Although Morningstar’s new methodology will have a significant impact on the asset management industry at first, it will not increase the frequency with which the firm changes fund ratings.
“While the impact analysis did not assess the frequency of ratings changes under the updated methodology, we do not expect it to rise substantially,” the firm said in the report. “This is because ratings would change only when an analyst conducts a formal review, which typically happens on an annual basis.”