The Effect of Morningstar Ratings on Mutual Fund Flows

Evidence from the U.S.

von Johanna Göckel

Prof. Dr. Alexander Hillert

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There exists a large literature on mutual fundflows and fund-specific determinants influencing flows. Past performance appears to be most salient as Sirri and Tufano (1998) show evidence on a convex flow-performance relation for U.S. mutual funds. Further academic research proves that investment costs such as load fees and operating expenses (Barber, Odean, and Zheng, 2005), advertising of funds (Jain and Wu, 2000), and tax motivations when realizing gains or losses from selling investments (Ivković and Weisbrenner, 2009) also affect mutual fund flows.

The one to five Star Rating of Morningstar, which was introduced in 1985, is well-established today. Morningstar as a brand is well-known and considered as an independent and reputable source of information. The accessible Star Rating information shows substantial effects on investors’ allocation decisions. Del Guercio and Tkac (2008) find statistically significant positive (negative) abnormal flows following Star Rating upgrades (downgrades). Contrary to the literature on the cross-sectional flow-performance relation, Del Guercio and Tkac (2008) find evidence on investor punishment of poorly performing funds since investors withdraw money from funds experiencing a rating downgrade. Furthermore, they defined the independent influence of Star Rating changes as the “Morningstar effect”,measuring additional dollars allocated to mutual funds as a consequence of a Morningstar Star Rating change.

This bachelor thesis analyzes how Morningstar’s Star Rating affects net fund flows of U.S. mutual equity funds and is structured as follows. The next section reviews the data and provides brief descriptions of Morningstar’s general rating methodology. In addition, Star Rating change events as well as the persistence of Star Ratings are evaluated. In section 3 I report the results of various regression analyses, using differently designed variables showing the effect of Morningstar ratings on mutual fund flows. Section 4 concludes.