Morningstar Now Ranks The Models . . . But Here's What You REALLY Need To Know

We recently got a note from Morningstar's data unit (different from the managed portfolio side of the company) that raised both eyebrows and questions. Apparently they've started assigning star ratings to investment models.

That's a direct reversal from what we've been told about the way the models database would relate to the familiar mutual funds and ETFs that still form the backbone of the company's analytic universe.

Only weeks ago, stars weren't a good fit for investment models. The feeds weren't compatible yet. In-house ratings might be rolled out some day, but not for the foreseeable future.

Now, suddenly, the stars are coming. As far as we're concerned, this reflects an effort to catch up and capture what is rapidly becoming the hottest space in asset management.

Morningstar is the entrenched data giant when it comes to mutual funds and ETFs. The SMA universe is also big, containing 22,000 distinct solutions.

But model uptake has lagged, with barely 1/10 that number of strategies in the database the last time I checked. It felt like Morningstar was missing an opportunity to remain relevant as the industry evolves beyond individual funds that you have to allocate on your own.

After all, when we talk to gigantic money managers like BlackRock and Invesco, models aren't just the hottest thing on the horizon. They're already a major driver of new flows into funds that would otherwise be racing to the bottom on fees.

It's not hard to figure out why. Anyone can spin up a lookalike large-cap core fund now and get crushed going head to head with the giants, which already have brand power and gravity on their side.

But if you can build your fund into a distinctive portfolio that serves a specific advisory goal, you can move the needle. Advisors will buy the portfolio and take the funds you select.

We can debate the virtues of truly open architecture, but the important thing here is the model-only structure that can be traded via TAMPs or simply pushed to advisors in more traditional trade-by-trade formats.

Going to models eliminates a lot of the headaches of building portfolios yourself from off-the-shelf funds. Just plug and play. The outside managers worry about every aspect of the client portfolio.

That's the traditional promise of the outsourced investment solution. Now you can really do it. 

Back to Morningstar, I think they recognize this now. As more advisors evolve toward a focus on the models and away from watching the individual funds, due diligence on the models becomes the critical link in the information chain.

Think of how the rise of mutual funds pushed individual stock analysis to the background. Yes, equity funds are built out of stocks, but how many advisors drill down to the individual security level when picking a fund for a client today?

I'm not shocked Morningstar wants to become a kingmaker here. They've got a lot of work to do before they provide the same depth of data that they do in their more conventional businesses.

And realistically, what difference does a half star make? Unless you're content to just run a screen and take the results, you're not really doing due diligence here . . . and compliance may not be happy to hear that.

Apparently a model is eligible a good rating if it submits quarterly holdings data, GIPS compliance and has 18 months in the database. There are exceptions and complications, but according to what we've heard, that's it. 

Legacy SMA providers and big shops get a pass. Disruptors and startups alike are at a disadvantage.

They just won't show up on the screens if you screen by stars. Zero stars.

The greatest manager on the planet could be invisible to you and your clients. You can do your own homework. 

We'll talk more about this. For now, we applaud Morningstar for recognizing the potential here. And we accept that star ratings are part of the mystique over there.

But it would be nice if the data operation could take a cue from the managed portfolio side of the company, which builds its own models and doesn't rely on outside ratings. That's how to get differentiated outcomes for your clients.

It takes work, but it's worth doing.


More Articles