Not long ago, I made a little fun of an ad for the Strong Funds that exaggerated its Morningstar stardom (all duly hinted at in the fine print). But today Michael, who asks that his last name not be used, rants at the Morningstar stars themselves.

“The two biggest problems I have with Morningstar stars [Michael writes] are:

1. Past results have nothing to do with future results.

“Everybody knows this but ignores this aspect of Morningstar’s ratings. Just because a manger had a hot streak doesn’t mean he’ll (why are they all he’s?) stay hot. More to the point, changes in managers do NOT impact the rankings.

2. (and this is the important one) The returns used to calculate the number of stars are based on total returns and over short time periods-NOT relative performance.

“To see the truly silly situation this creates all one needs to do is pull up all the four and five star Japan funds, but…aye, there’s the rub. There are no four or five star Japan funds! None. And only 3 of 22 have three stars—the “average” ranking.

“Now pull up all the five star Europe funds. Amazingly, over two-thirds of all Europe funds have five stars (37 of the 55 ranked by Morningstar). Another ten funds have four stars. Wow…it seems that all the talented managers have been managing Europe funds, not Japan funds. Who would fish for good stocks in the horrible pond of Japan? Don’t they know better?

“Japan has been a horrible place to invest over the last five years, while any dolt could have made a killing in Europe, but does that mean the same will be true over the next five years? What would have the Morningstar ratings looked like at the end of 1989?”

Thanks for writing my column for me, Michael. I would only add, in Morningstar’s defense, that they, too, suggest investors not rely too heavily on their stars in choosing funds — especially the stars for the shorter time periods. And they do try to measure a fund’s performance relative to funds with similar objectives. But obviously not when it comes to measuring Japanese funds against each other instead of against all foreign funds. You make an excellent point in this regard.

Monday: What About Japan, Anyway?


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