Too often, investors get stars in their eyes when they’re evaluating a fund, and can’t see much else.
I’m referring to the fund ratings doled out by independent research firms like Morningstar. If a fund rates five stars, the investor will automatically buy or keep; if just one or two, they sell.
I happen to think that Morningstar is a great company. It transformed the mutual-fund industry through the “democratization of data,” to use a term coined by its head of research Don Phillips. What Mr. Phillips and his team did, back in the 1980s, was to open the black box of mutual funds, and enable the investing public to see and analyze what the funds were investing in, how the funds were governed and performing, and what they cost in terms of fees and risk. They also adopted the star-rating system to give investors a way to evaluate the fund’s track record relative to other similar funds, in terms of return and risk.
This star-rating system has been explained and refined over the years, and Morningstar has always been the first to qualify its limitations in predicting future performance.
Many investors, however, fail to consider all the other data that Morningstar publishes on funds, and make their decisions entirely based on the stars. This, to my mind, is pure astrology and not prudent invest