The value of Morningstar ratings: evidence using stochastic data envelopment analysis

Abstract

Purpose

This paper aims to contribute the existing finance literature by examining whether the ratings of Morningstar in Australia provide useful information for an investor by way of investigating the efficiency of domestic Australian equity funds that received a rating as at November 2005.

Design/methodology/approach

This paper proposes the application of a simulation approach to stochastic data envelopment analysis (SDEA) based on Excel/@RISK, which was first proposed by Premachandra et al. in 1998. The analysis provides a variety of informative statistical information about the stochastic properties of the efficiency figure. Efficiency is measured by looking at fund performance, fund cost, fund risk exposure and manager ability over the period December 1990‐November 2005.

Findings

The introduction to portfolio performance evaluation of a new tool for evaluating fund performance (namely, the efficiency rating) is recommended. From a sample of Australian domestic equity managed funds we find that evidence exists to suggest that efficient funds are likely to receive an upgrade in rating in the medium to long term.

Practical implications

The benefit of the present paper for investors and fund managers is the improved efficiency of managed funds in terms of expense and risk.

Originality/value

The present paper further contributes to the literature by reinforcing the importance of SDEA as a tool for measuring the efficiency of decision‐making units within investment fund markets.

Citation

Watson, J., Wickramanayke, J. and Premachandra, I.M. (2011), "The value of Morningstar ratings: evidence using stochastic data envelopment analysis", Managerial Finance, Vol. 37 No. 2, pp. 94-116. https://doi.org/10.1108/03074351111103659