Morningstar Ratings Change Celebrate 5 Years

Morningstar also cooked up a revised risk measure, based on the utility function, which "assumes that at any return point, investors would gladly trade some risk for a bit more safety, whereas the old measure only focused on one point on the risk/reward curve." And investor behavior supports this. "We've seen that investors use high-risk funds rather poorly as they bail out after losses that were too great to endure only to miss out on the rally that ensued," Kinnel explains.

In its recent research, the firm found that five-star funds "have modestly outperformed four-star funds, and four-star funds have modestly outperformed three-star funds, and so on down the line," according to Kinnel. "When you compare opposite ends, you see that five-star funds outperformed one-star funds by a healthy margin … We also found that higher-rated funds received a higher three- and five-year rating over the ensuing periods."

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Janet Levaux is the managing editor of Research; reach her at [email protected].