Morningstar Magazine - February/March 2018 - 48

Strategies

and calculated the average return for the next
one-, three-, six-, 12-, 36-, and 60-month horizons.
The investor would have received these returns
if he or she had held an equal-weighted portfolio
of funds with Analyst Ratings at that month-end
in U.S. dollars. From these returns, we then
subtracted funds' category average returns, with
positive excess returns indicating outperformance versus category peers and negative
excess returns denoting underperformance.
We reconstituted the rating groups each
month-end between November 2011 and April 2017,
calculating the future excess returns and
averaging across the month-ends to produce a
final average excess return for each cohort
and event horizon. We ran three variations of the
event-study framework: excess return versus
the category average; excess return versus
the category benchmark index; and CAPM alpha
versus the category benchmark index.
The first table in E X H I B I T 3 shows the cumulative
excess returns of each cohort versus a relevant
category average. In general, the Analyst Rating
succeeded in sorting funds by future excess
returns. This was most pronounced among equity
and allocation funds, less so among fixed-income
funds. While medalist funds generated
positive excess returns, on average, so too did
Neutral-rated funds. This will be the subject

of future study, but sorting appears to improve
once we account for risk (as we'll see in the CAPM
alpha findings).
The second table in EXHIB IT 3 shows cumulative
excess returns of each cohort versus a relevant
category index. These findings are directionally
similar to the first table's. However, the magnitude
is less, reflecting the reality that the indexes
do not levy fees and, thus, are harder to beat. Still,
we found that Gold-rated funds produced positive
excess returns, on average, and there was
meaningful separation between the excess returns
of Gold-rated funds and Neutral- and Negativerated funds. That said, the average Silver- and
Bronze-rated fund did not generate positive excess
returns versus the category indexes, and the
average Neutral-rated fund had a smaller deficit to
the category index than the average Bronze-rated
fund. This, too, warrants closer examination,
though it reflects differences in the relative level of
risk taken by funds in these cohorts.
The bottom table in EXHIB IT 3 shows annualized
CAPM alphas of each cohort versus a relevant
category index. The findings are notable because
they're risk-adjusted for the index's volatility.
This approach aligns well with the Analyst Rating
methodology, as analysts are assessing funds'
future risk-adjusted returns. We found the Analyst
Rating succeeds at sorting funds on this basis,

EXHIBIT 2

Good as Gold The premiums of medalist equity funds were superior to those of
Neutral- and Negative-rated funds.
Growth of $1
1.10
Œ
„
´
‰

0.95
0.90
Á

11/2011

11/2012

Source: Morningstar. Data as of 4/30/2017.

48

Morningstar February/March 2018

11/2013

11/2014

11/2015

11/2016

especially over longer horizons. Medalist funds
achieved positive average annual alphas
over the 36- and 60-month event horizons, while
Neutral- and Negative-rated funds suffered
negative alphas. This monotonic pattern generally
held across asset classes, though it was less
pronounced among fixed-income funds.
Silver- and Bronze-rated funds performed far better
than Neutral- and Negative-rated funds when
measured on CAPM alpha than when measured on
excess returns versus the category average
or category index. This was particularly evident
among fixed-income funds. This underscores
the centrality of risk in the analysts' assessment
and, in turn, the importance of capturing
this dimension when evaluating the success of the
Analyst Ratings in predicting future performance.
Key U.S. Findings

We next examined the performance of the Analyst
Ratings assigned to U.S.-domiciled funds under
the event-study framework. The study did not
break out the United States specifically, but we
can extract the results following the same methods
that we used to produce the global findings.
The first table in EXHIB IT 4 shows that the
Analyst Rating generally succeeded in sorting the
"universe" of U.S. funds based on future average
excess returns versus the category average.
However, every cohort notched positive average
excess returns over each event horizon, and
there was less separation than we hoped between
Silver- and Bronze-rated funds and Neutraland Negative-rated funds over the 60-month
horizon. Among equity funds, Gold-rated
fund outperformed handily, but the performance
of Silver- and Bronze- rated funds was
disappointing when compared with Neutral- and
Negative-rated funds. That picture brightened
among allocation funds, as medalists outperformed the relevant category averages by a wider
margin than Neutral- and Negative-rated funds
did. But performance was mixed among fixedincome funds, where Neutral- and Negative-rated
funds outperformed the category averages by
as much, if not more, than medalists.
The findings in the second table in EXHIBIT 4
are directionally similar to those in the first table,



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