Morningstar, a Chicago-based investment research firm, is known for its mutual fund ratings system. The star system, which rates funds from one to five stars, is based on past performance and is used by investors to make investment decisions. However, critics argue that the system is flawed and potentially misleading. They claim that it encourages chasing past performance, which is not an accurate predictor of future results.

Morningstar defends its system, stating that it is only one tool investors should use when making decisions and it does not guarantee future performance. The firm also emphasises that its ratings are based on risk-adjusted returns, meaning it takes into account the level of risk a fund manager takes to achieve their returns.

A study by The Wall Street Journal found that funds with five-star ratings attract the majority of new investor money. Yet, these funds do not always maintain their high ratings. In fact, only 10% of five-star funds maintained their rating over a five-year period. Additionally, funds that earned five stars were more likely to suffer a significant drop in rating than to maintain their high rating.

This raises concerns about the effectiveness of the star system and whether it is truly beneficial for investors. Despite these concerns, Morningstar’s star system remains a popular and influential tool in the investment world.

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