Understanding two well-known fund rating systems
Picking the best funds for your portfolio can be complicated given the vast amounts of data and opinion in the market. Private investors often find it difficult to discern which funds are most suitable for portfolio inclusion, or which stock pickers are the real deal.
There are best buy lists out there, but their reputations have been slightly tainted by the Neil Woodford debacle, with Hargreaves Lansdown (HL.) in the doghouse for retaining the LF Woodford Equity Income Fund (BLRZQ73) on its ‘Wealth 50’ list right up until the money manager gated the fund in June.
Nevertheless, you certainly shouldn’t discount some very informative independent fund rating systems that investors can lean on for ideas. In this article, we examine the mechanics of two ratings systems and flag some of the funds that stand up to scrutiny.
EXAMPLES OF FUNDS WITH MORNINGSTAR 5-STAR AND GOLD RATINGS
JPMorgan US Equity Income
Vanguard LifeStrategy 20%/40%/60%/80% Equity Funds
EXAMPLES OF FUNDS WITH MORNINGSTAR 5-STAR AND SILVER RATINGS
Jupiter Strategic Bond
M&G Global Macro Bond
EXAMPLES OF FUNDS WITH MORNINGSTAR 5-STAR AND BRONZE RATINGS
Investec UK Alpha
Merian UK Smaller Companies
GOING FOR GOLD
Independent investment research provider Morningstar’s fund ratings offer a powerful fund assessment tool. They include the Morningstar ‘star rating’, which is an assessment of a fund’s track record relative to peers and offers investors a first port of call in the fund evaluation process.
The star rating shows how well a fund’s past returns have compensated shareholders for the amount of risk it has taken on, with the star ratings calculated at the end of every month. Importantly, to receive a Morningstar rating, a fund must have a track record of at least three years.
Helpfully, funds are given a Morningstar analyst rating of Gold, Silver, Bronze, Neutral or Negative, reflecting a Morningstar analyst’s conviction in the prospects for outperformance.
This Morningstar analyst rating provides a forward-looking assessment of the fund’s ability to outperform its peer group or benchmark on a risk-adjusted basis over a full market cycle.
Continuously monitored and re-evaluated at least every 14 months, the Morningstar analyst ratings are assigned to funds that have attracted the most assets and investor interest.
From an investor’s perspective, these analyst ratings, based on five key pillars – people, parent, process, performance and price – and face-to-face meetings, can be used to unearth funds the analysts believe will perform better than similar investments over a full market cycle.
Among the open-ended elite boasting a five-star Morningstar rating combined with a Gold Morningstar analyst rating is the Terry Smith-steered Fundsmith Equity (B41YBW7), which puts money to work with high-quality, cash generative businesses that will compound in value over time.
Morningstar analyst Peter Brunt dubs Fundsmith Equity ‘one of the strongest options for investors seeking exposure to high-quality global equities’. Smith is described as ‘an original thinker’ who has ‘often demonstrated his willingness to bet against the crowd by taking a longer-term view’.
EXAMPLES OF FUNDS WITH A FIVE-CROWN RATING FROM FE TRUSTNET
AXA World Funds Framlington UK
BlackRock Sterling Strategic Bond
Liontrust UK Micro Cap
Financial data provider FE Trustnet also offers ratings that can help investors to identify the best funds. Its FE Crown fund ratings identify the best performing and most consistent funds over the long term. Crucially, the fund providers are not charged for a rating, which means, like Morningstar’s ratings, they are entirely independent.
FE Crown fund ratings are updated twice a year (during January and July) and enable investors to separate the benchmark-beating wheat from the underperforming chaff among unit trusts, open-ended investment companies (OEICs) and investment trusts.
Since they focus on a fund’s outperformance (or not) of an index, the FE Crown fund ratings are aimed at active funds, while tracker-type funds are rated using FE’s Passive Crown rating methodology.
Quantitative ratings range from one to five. These ratings are designed to help investors to spot funds which have exhibited superior performance in terms of stock picking, consistency of outperformance versus a credible benchmark and the generation of results at a relatively low risk.
The top 10% of funds are awarded five FE Crowns. Among this highest tier are the likes of LF Ruffer Gold (B8510Q9), the Robin Geffen-guided Neptune Russia (B86WB79) and Lindsell Train Global Equity (B3NS4D2), not to mention private investor favourite Scottish Mortgage (SMT) from the investment trusts sector.
The next 15% receive four FE Crowns and each of the remaining three quartiles are given three, two and one FE Crown(s) respectively.
FE Crown’s ratings are purely quantitative and backward looking and are therefore no guide to the future. They are not fund recommendations either and shouldn’t be regarded as specific advice.
Investors still need to consider qualitative measurements, the track record of the fund managers running the portfolio and the expertise of the asset management group behind the fund in the sector in which the portfolio is allocating capital.
A RECENT AWARD WINNER
Unicorn UK Ethical Income (BYP2Y51) recently won a five-Crown rating from FE Trustnet, having just become eligible for the first time to be considered for an award.
The fund was launched in May 2016 and invests in companies which meet certain ethical guidelines. It is essentially an ethically screen version of Unicorn UK Income Fund (B00Z1R8) and it outperformed this fund by 3.1% in the year to 30 September 2018.
The top holdings currently include cinema operator Cineworld (CINE), financial services group Secure Trust Bank (STB) and promotional products specialist 4imprint (FOUR). It has achieved 5.59% annualised total return over three years.