MORNINGSTAR STAR-RATING SYSTEM Proceeding E Book 4A Turky

1005 based upon an agregation of the three-, five-, and 10-year risk-adjusted return for funds with 10 year risk-adjusted return for funds with 10 years or more of return history, three- and five- year risk-adjusted returns for funds with five to less than 10 years of return data, and three- year risk-adjusted returns for funds with five to less than five years of return data. To calculate the risk-adjusted return for the fund by adjusting returns for expenses and other costs automatically taken out of the fund, and then by adjusting for front-end and deferred loads. Next, εorningstar calculates a ‗‗εorningstar return‘‘ in which the expense-and load-adjusted excess is return divided by the higher of two variables: the excess average return of the fund category or the average 90-day T-bill rate; 153 Morningstar then calculates a Morningstar risk measure, which is calculated differently from traditional risk measures, such as beta and standard deviation that both see greater-than and less-than-expected returns as added volatility. Morningstar believes that most investors greatest fear is losing money, which Morningstar defines as underperforming the risk-free rate of return an investor can earn from the 90-day Treasury bill. Hence, their risk measure only focuses on downside risk. 154 To calculate risk, Morningstar plots monthly returns in relation to T-bill returns, adds up the amounts by which the fund trails the T-bill return each month, and then divides that total by the time horizons total number of months. This number, the average monthly underperformance statistic, is then compared with those of other funds in the same broad investment category to assign the risk scores. The resultant Morningstar risk score expresses how risky the fund is relative to the average fund in its category. To calculate a funds summary star rating, Morningstar calculates the three-, five-, and 10- year Morningstar return and risk. For each time horizon, the Morningstar calculates its raw rating by subtracting the Morningstar risk score from the Morningstar return score. Then the three numbers one for each time horizon are then given subjective weights. The three-year number receives a 20 weighting, the five-year a 30 weighting, and the 10-year a 50 weighting. In the case of young funds funds with three to less than five years of return data, the three-year number receives a 100 weighting; in the case of middle-aged funds funds with five to less than 10 years of return data, the three-year number receives a 40 weighting and the five-year number receives a 60 weighting. With these weights, Morningstar calculates the weighted average of the numbers. See Figure 1 The resulting number is then plotted along a bell curve to determine the funds star rating. If the fund scores in the top 10 of its broad investment category, it receives a rating of five stars; if the fund falls in the next 22.5, it receives four stars; if it falls in the middle 35, it receives three stars; if it lies in the next 22.5, the fund receives two stars, and if it is in the bottom 10, it receives one star. 155 Figure 1: Distribution of Star Ratings Within a Category in the Morningstar Rating System Source: BENZ Christina, TERESA Peter, KINNEL Russel, Morningstar Guide to Mutual Funds, John Wiley and Sons, New Jersey, Jan 2003, p.32 bond and taxable bond. But Turkish pension mutual funds differ from any aspects asset classes, investment strategies, size etc. from US mutual funds. Therefore in the study pension mutual funds category numbers are enlarged. 153 BLAKE R. Christopher, MOREY Matthew R., Morningstar Ratings and Mutual Fund Performance, Journal of Financial and Quantative Analysis, Vol.35, No.3, September 2000, p.457 154 Focusing only on downside risk is neither unique to Morningstar nor new; it was explored by Markowitz 1959 and incorporated into an asset-pricing model by Bawa and Lindenberg 1977. 155 BLAKE R. Christopher, MOREY Matthew R., a.g.e., p.458