Morningstar, FE and beyond: Inside the making of a top rated fund

The major firms behind fund ratings have set out their criteria for earmarking the funds that are outperforming their peers.

Earlier this month Morningstar awarded Vanguard’s LifeStrategy range a ‘gold’ rating, prompting Vanguard to claim it was the only gold-rated multi-asset range in the UK.

Hargreaves Lansdown head of investment research Mark Dampier recently questioned the performance of the LifeStrategy range, arguing its success might not last over future market cycles.

By giving a fund a gold rating, Morningstar says it expects the fund to outperform the relevant performance benchmark and/or peer group within the context of the level of risk taken over the long term, usually five years.

A fund must distinguish itself across five key areas: process, performance, people, parent group and price. Analysts assign a rating of positive, neutral or negative to each factor.

Data from FE shows all Life-Strategy funds would sit in 1st or 2nd quintile cumulatively  since 2004. All the funds performed better than LifeStrategy’s peers on the downside in 2008, 2009 and 2011.

Morningstar senior analyst Randal Goldsmith says: “The main disting-uishing factors of the Vanguard range versus the rest of the sector are the lowest-cost multi-asset exposure, a transparent fixed allo-cation approach and that about a third of the portfolio is invested in funds that have Morningstar gold analyst ratings.”

But Morningstar says the most important factors are the simplicity of the LifeStrategy investment approach and the commitment of the firm to pass on savings to investors from cost efficiencies as the size of the range grows.

For Tilney Group, the cost of passive funds is considered the most important factor when ranking funds. With passive strategies based on market cap weighting, Tilney mostly rates funds based on the way it replicates an index. The Vanguard multi-asset range is part of some discretionary portfolios offered by Tilney.

Tilney Group managing director Jason Hollands says: “If you run a multi-asset fund, some asset classes can’t be accessed by passives. A true multi-asset portfolio is not just investing in equities and bonds.”

FE awards “crown” ratings for funds that strongly outperform their benchmarks. Crowns are based on scores in alpha, consistency and volatility, with the top 10 per cent scoring five crowns, the next 15 per cent scoring four crowns, and three, two and one crowns each covering 25 per cent.

FE portfolio manager Oliver Clarke-Williams says: “Multi-asset funds are rated the same as other funds, with the Vanguard Life-Strategy range being no exception. Almost all the funds in the range score five crowns, with the exception of the 20% Equity fund, which scores four crowns.”

In FE’s latest passive fund rating, the highest rating is given to passive funds and exchange-traded funds based on their ability to track a benchmark, and particularly to track error and fund size.

At FundCalibre, funds receive the “elite” rating when they have a greater than 60 per cent chance of delivering outperformance, mainly due to the skill of the fund manager.

Managing director Darius McDermott says there is no sliding scale of bronze to gold, or one star to five stars, as with other firms.

He says: “Fund managers who pass the AlphaQuest filtering test are subjected to further detailed qualitative analysis.

“Our research team will interview the fund manager face-to-face, to better understand and assess how their investment process and style give them an edge over other managers.”

Funds are also tested on the consistency of the investment philosophy through the portfolio, a review of the team behind the managers and against their peer groups.