As indicated in the section on computations, most of Morningstar's performance measures are based on returns for the 36 months preceding the reporting date. However, risk-adjusted ratings and the related star ratings are determined for several periods (1,3, 5 and 10 years), data permitting. Moreover, an overall star rating is computed for each fund, using results for 3, 5 and 10 years, as available. This overall measure is often used for comparisons and is likely to be the basis for labeling a fund as "five-star", "four-star" and so on.
From statistical and economic viewpoints, the use of mixture of different periods when ranking funds is difficult to justify. For some of the funds used in the comparison, values are based on the last three years. For others, the values are based on a combination of the last three years and the last five years. For yet others, the values are based on a combination of the last three, five, and ten years. The table below shows the number of diversified equity funds in our sample in each of these groups at the end of 1996.
Available ratings, diversified equity funds
Available Number of Funds 3 Years 543 3 and 5 Years 320 3, 5, and 10 Years 423 Total 1,286
Only the last three years are analyzed for 543 out of the 1,286 funds. For an additional 320 funds, both three year and five-year results are used. In such cases the five-year figures are given a higher weight, but since they include the most recent three years, the influence of the latter is still substantial. A similar situation applies for the 423 funds for which ten years of historic returns are available. While the weightings of the five-year and ten-years results are considerable, each of these periods includes the most recent three years, still giving the latter substantial influence.
The importance of the last three years can be seen by comparing the number of stars awarded a fund based on the last three years with its overall star rating. The following table provides a breakdown of the number of funds based on the two ratings.
3-Year versus overall ratings, diversified equity funds with returns for more than 3 years
3yr = 1 3yr = 2 3yr = 3 3yr = 4 3yr = 5 Overall = 1 69 7 1 0 0 Overall = 2 27 193 49 2 0 Overall = 3 7 43 303 73 2 Overall = 4 1 8 67 256 42 Overall = 5 0 0 0 29 107
The results are striking. For 72.2% of the funds, the 3-year and overall ratings are identical. And for 98.4% of the funds, the 3-year and overall ratings differ by no more than one star.
Of course, this comparison is heavily influenced by the funds for which only three years of data are available and for which the 3-year and overall ratings must be the same. When only funds with longer histories are considered, the results become somewhat less dramatic, as shown in the next table.
3-Year versus overall ratings, diversified equity funds with returns for more than 5 years
3yr = 1 3yr = 2 3yr = 3 3yr = 4 3yr = 5 Overall = 1 17 7 1 0 0 Overall = 2 27 83 49 2 0 Overall = 3 7 43 141 73 2 Overall = 4 1 8 67 109 42 Overall = 5 0 0 0 29 35
Even in this case, the two ratings are the same for 51.8% of the funds. And for 97.2% of the funds, the rating based on the last three years is within one star of the overall rating.
While it is possible that the decade from 1987 through 1996 is not representative in this regard, it seems likely that 3-year and overall star ratings will be fairly similar across funds in the future. This is just as well, for the economic and statistical properties of the latter are almost impossible to assess. For practical and theoretical reasons, we deal henceforth with only the measures computed using 36 months of returns, leaving further analysis of any differences between 3-year and overall star ratings to others.
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