Have you been scouting for Morningstar Gold-Rated funds in a specific category and have not managed to find any? Fund ratings can be a helpful tool in whittling down the enormous universe of available funds to choose from and deciding which ones to add to your portfolio. But if Morningstar analysts don’t see any funds in a category as worthy of a Gold rating in a category, then there won't be any.
“If you can't find a Gold-Rated fund in a particular category, it simply means we don’t think there is someone strong enough to earn a gold rating,” says Christopher Traulsen, director of fund research at Morningstar. There are myriad reasons that funds might not cut the mustard: lack of talented managers in the category, high fees or a poor record in beating the benchmark, to name just a few.
We have looked at 10 Morningstar categories that don’t have any Gold-Rated share classes. It's worth noting we say "share classes" and not "funds" here, because since Morningstar updated its rating system last year, ratings may vary across a fund's share classes - it may have one rated Gold and another Neutral. This is typically because of different fees, with high charges on older share classes likely to eat into returns.
|
10 Categories With No Gold Ratings |
| USD High Yield Bond |
| Latin America Equity |
| UK Equity Income |
| GBP High Yield Bond |
| Global Large-Cap Value Equity |
| UK Mid-Cap Equity |
| US Flex-Cap Equity |
| Global Flexible Bond |
| Global Emerging Markets Corp Bond |
| Europe Small-Cap Equity |
Our list embraces very different areas of the market, from UK Equity Income to Latin America Equity and USD High Yield Bonds. While most categories have share classes which have a Morningstar Analyst Rating, none hold a coveted Gold rating.
The USD High Yield Bond category, for example, has 209 share classes with a rating, of which 30 are Silver, 57 are Bronze, 96 are Neutral, 26 are Negative.
How are Morningstar Ratings Awarded?
To understand why certain categories don’t have any Gold-Rated share class, we need to understand how Morningstar analysts attribute their ratings. This scale goes from Negative through Neutral to Bronze, Silver and, eventually, Gold.
The main thing that drives a fund's rating are the People and Process pillars; only funds where analysts have a very high conviction in People and Process can achieved a gold rating. “It can be quite hard to get,” says Traulsen.
For example, the Morningstar Analyst Rating for the I Acc share class of Fundsmith Equity remains Gold. The fund has produced a 5-year annualised returns of 20.55% - some 5.64 percentage points above its Morningstar Category, the Global Large-Cap Growth Equity. Morningstar analysts have high conviction in its manager, Terry Smith, and his "buy and hold" investment philosophy. “He is an original thinker and has often demonstrated his willingness to bet against the crowd by taking a longer-term view,” they say.
The second thing that matters is how managers in a certain category perform over time and, consequentially, how great an opportunity there is for them to deliver "alpha" in the category. Alpha is the gains a manager delivers over and above the benchmark.
In essence, the impact the pillar scores have on the final rating is scaled by the spread of alphas earned by active funds in the category over time, as this represents the opportunity set for alpha in the category. “For categories where managers haven't shown much ability to deliver alpha through time, this measure will be smaller than for categories where it has been large,” says Traulsen.
Why so Few Gold-Rated Active Funds?
Managers in some categories have a very hard time beating their passive counterparts. Traulsen points out at the US large-cap and EUR government bonds categories as two areas where managers find it difficult to beat their benchmark. “You can see that most of Gold-Rated share classes in these categories are on passive funds,” he says. “They are good examples of categories where active managers don't have much room to add value and they charge high fees compared to passives. So we would generally expect cheap, well-designed passives to be a better choice for investors.”
Indeed, the Vanguard Euro Government Bond Index fund is Gold-Rated, as Morningstar analyst Jose Garcia-Zarate believes this is a market where the opportunity to add meaningful value over a standard benchmark in a “sustained manner” has been “severely reduced”.
And the same story applies to the Gold-Rated Legal & General US Index Trust. Morningstar analyst Briegel Leitao points out the US equity market is highly liquid and efficient, meaning that stock-specific valuation information is quickly incorporated into stock prices and so “this makes broadly diversified, low-cost passive strategies the default option for investors seeking this market exposure".
While investors may feel discouraged to find there are no Gold-Rated options in the category they are scouring, it doesn't mean they should shun that investment area, only that analysts are not convinced there is a fund that is worthy of a Gold rating at the moment. “If we don’t think there is something good enough to be gold rated, there is no reason to give a gold score in a specific category,” says Traulsen. “We are here to tell when funds are good or not.”
