What Is the Morningstar Risk Rating?
The Morningstar risk rating, or simply Morningstar rating, is a ranking given to publicly traded mutual funds and exchange-traded funds (ETFs) by the investment research firm Morningstar. Risk is assessed across five levels designed to help investors quickly identify funds to consider for their portfolios. Funds receive ratings ranging from 1 to 5, with 1 given to the worst performers and 5 for the best. The ranking is based on variations in a fund's monthly returns – with an emphasis on downside variations – as compared to similar funds.
Understanding the Morningstar Risk Rating
Morningstar ratings are based on the fund's past performance as compared to other funds in its Morningstar category. The risk rating is frequently a starting point for additional research and is not buy or sell recommendation.
In the risk rating process, 10% of a category's funds with the lowest measured risk are rated as low risk. The next 22.5% are rated below average, the middle 35% are average, the next 22.5% above average, while the top 10% are rated as high risk. Morningstar measures risk for as many as three periods (three, five, and 10 years). These separate measures are then weighted and averaged to produce an overall measure for the fund. Funds with less than three years of performance history are not rated.
The company rates individual funds and sells the ratings along with other research to investors.
Morningstar also provides category ratings and peer-group ratings to help investors further compare funds. For example, as of year-end 2018, Morningstar assigns a 3.9-star rating to municipal bond funds as a group, a 3.4-star rating to domestic stock funds and a 3-star rating to international stock funds.
- The Morningstar risk rating is a ranking given by research firm Morningstar to publicly traded mutual funds and exchange-traded funds (ETFs).
- Morningstar ratings are based on the fund's historical performance compared to other like funds.
- Critics argue that Morningstar ratings don't look at the bigger picture where the funds are compared to the marketplace.
- Morningstar also provides category and peer-group ratings.
Other Risk Rating Providers
Morningstar is not the only company that creates risk ratings. Other rating creators include Thomson Reuters Lipper, Zacks Investment Research, Standard and Poor's, and TheStreet. Business and finance publications such as Forbes and U.S. News & World Report also rank and rate funds, as well as other asset classes, for their readers. In many cases, they base much of their analyses on ratings from Morningstar and the others.
Criticism of Morningstar Risk Ratings
While Morningstar ratings are considered essential in guiding investors toward quality investment decisions, they are not immune to criticism. Some financial analysts have criticized these ratings because they only compare funds to other funds, in isolation from the greater marketplace. As a result, a fund's rating may reflect its suitability for the particular market more than its overall viability and potential. For example, as prices are rising in a bull market, funds with historically safe stocks from companies such as AT&T tend to perform well. Conversely, when prices are falling in a bear market, funds featuring speculative stocks from companies such as Tesla Motors and Charles Schwab tend to do better. As a result, some investors prefer ratings that keep the market conditions in mind, such as the ratings generated by Forbes.
Example of Morningstar Risk Ratings
To get an idea of how Morningstar assigns its risk ratings, let's look at its data on the iShares Nasdaq Biotechnology ETF (IBB). The exchange-trade fund is rated as presenting investors with above-average risk on a three-, five- and 10-year basis, based on a weighted average of the performance figures. Over the past 10 years, the fund has delivered an annualized total return of 15.38%, compared to 11.59% for the benchmark S&P 500 index.