The Future of Mutual Fund Ratings:
Dec 17th, 2006 | Filed under: Performance, Analytics & MetricsThis article in Investment News highlights the evolving nature of fund ratings. Says Investment News:
“Mutual fund tracker Lipper Inc. is evaluating plans to overhaul its fund classification system, a move that could pose formidable competition to rival Morningstar Inc.
“The new classification system would take into account a fund’s volatility relative to its benchmark, as well as its market capitalization and style, according to those familiar with the New York-based company’s plans.”
Okay, so this isn’t rocket science. But it might represent an important step forward for the archaic methodologies used to rate mutual funds. Lipper is keeping a tight lid on things:
“‘It’s possible that we will introduce a new classification system, but we have made no commitment at this time,’ said Shana Gorsky, a company spokeswoman.”
Lipper aims to unseat Morningstar as the arbiter of good taste in the mutual fund industry.
“‘I think Morningstar has had the market cornered for so long, they have built up such a name with the public, that when you talk to clients about a fund, the Morningstar rating always comes up,’ said Nicholas Spagnoletti, a partner with Macro Consulting Group LLC in Parsippany, N.J.”
Lipper is the owner of the HedgeWorld (a.k.a. Lipper TASS) database of hedge funds. So one might guess that Lipper’s new mutual fund rating system would borrow some of the intellectual capital developed while trying to rate hedge funds.
Since mutual funds tend to be high correlated with each other, they are usually grouped into discrete buckets for analysis (witness Morningstar’s style boxes). For example, two large cap US value funds can easily be compared with each other and ranked against a common benchmark (S&P500). But hedge funds are more heterogeneous than mutual funds. Even within strategy buckets, they tend to have a high level of dispersion. So hedge fund ranking brings a host of new issues to the table (which benchmark? what timeframe? kurtosis? skewedness?…)
Meanwhile, over at Morningstar, hedge funds have also been on the radar screen. So the firm went out and bought hedge fund database InvestorForce last summer. At the recent “World Hedge Funds Summit” in Toronto last month, I asked John Rekenthaler, VP of Research and Product Development at Morningstar, whether the lessons learned from the firm’s foyer into hedge fund rating would eventually be applied to their core mutual fund business. He agreed this would likely occur.
We believe that rating techniques for mutual funds and hedge funds will eventually converge. After all, a mutual fund is essentially a marketing package (a “host fund”) containing ETFs (beta) and ”embedded hedge funds” (alpha). Once the major components of beta have been stripped out of a mutual fund, what remains can be analyzed as a hedge fund. Since most hedge funds also contain a healthy measure of beta, they too need to be boiled down to isolate their alpha.
So mutual funds and hedge funds are really all in the same game: alpha. There is no reason to maintain two sets of rating systems. At the end of the day, it’s really an apples to apples comparison. It’s all about alpha.
- Alpha Male
Read Article in Investment News: Lipper May Upgrade Classification
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