Investment Products and Services Launches

Morningstar Grows Fund Ratings System with Quantitative Rating; First Trust Merges Two Funds; and Vanguard Changes Benchmarks for Funds. 

Morningstar, Inc. has announced the expansion of its fund ratings system by launching the Morningstar Quantitative Rating, which uses a machine-learning model to rate six times more funds than are rated by Morningstar analysts in the United States.


The Quantitative Rating is an extension of the Morningstar Analyst Rating for funds, which provides an analyst’s forward-looking assessment of a fund’s ability to outperform its peer group or a relevant benchmark on a risk-adjusted basis over a full market cycle. Morningstar manager research analysts assign Analyst Ratings to approximately 1,800 open-end and exchange-traded funds (ETFs) and together with the Quantitative Rating, cover more than 10,000 funds, representing more than 30,000 share classes in the United States.


“Investors can use the Quantitative Rating, together with our other fund ratings, to assess funds and improve their odds of success,” says Jeffrey Ptak, Morningstar’s global head of manager research. “The Quantitative Rating algorithmically extends the objective, rigorous analysis that our manager research analysts conduct to thousands of additional funds, providing investors with broader coverage than ever before with the independent perspective they have come to know and trust from Morningstar.”


Using an approach rooted in artificial intelligence, Morningstar’s machine-learning model incorporates the decision-making processes of manager research analysts, their past rating decisions, and the data used to support those decisions. The machine-learning model is then applied to funds not covered by Morningstar analysts. This process generates the Quantitative Rating, which is analogous to the rating a Morningstar analyst might assign if an analyst covered the fund. The scale for the Quantitative Rating is the same as the Analyst Rating: gold, silver, bronze, neutral, and negative. Funds that receive the Quantitative Rating will receive Quantitative Ratings of positive, neutral, or negative for each of the five pillars—parent, people, performance, price, and process. Funds will either receive an analyst rating or a Quantitative Rating, but not both. 


“The expansion of our fund ratings with the Quantitative Rating is a great example of our commitment to innovation and leveraging recent advances in technology to further educate investors,” says Lee Davidson, Morningstar’s head of quantitative research. “We’ve trained our machine-learning model to emulate how our analysts make decisions, greatly expanding fund coverage and the proven insights we provide to investors.”


The Quantitative Rating for funds in the United States is available for, Morningstar Data, Morningstar Office Cloud, Morningstar Direct Cloud, and Morningstar Manager Research. The rating will be available in Morningstar Essentials and Morningstar Advisor Workstation by March 31. The rating was initially introduced in June 2017 with a limited release in Morningstar Direct.  


Morningstar will host a webinar on Wednesday, March 21 at 1 p.m. CT, led by a panel of Morningstar research leaders, about the Quantitative Rating and what’s behind the machine-learning technology used to generate the rating; webinar registration can be found here. The full Quantitative Rating methodology is available here. 


In December 2017, Morningstar analyzed the global performance of the Morningstar Analyst Rating for funds, finding that the analyst ratings effectively sorted funds based on their average future risk-adjusted returns; the report is available for download here.


First Trust Merges Two Funds


First Trust Advisors (FTA) announced that the board of trustees of First Trust Strategic High Income Fund II (FHY), a closed-end fund managed by FTA, and First Trust High Income Long/Short Fund (FSD), another closed-end fund managed by FTA, approved the merger of FHY into FSD. FSD will be the surviving fund. 


Under the terms of the proposed transaction, which is expected to be tax-free, the assets of FHY would be transferred to, and the liabilities of FHY would be assumed by FSD, and shareholders of FHY would receive shares of FSD with a value equal to the aggregate net asset value of the FHY shares held by them. It is currently expected that the transaction will be consummated later this year, subject to requisite shareholder approval and satisfaction of applicable regulatory requirements and approvals and customary closing conditions. Upon completion of the proposed transaction, the investment objectives and strategies of FSD will remain unchanged. 


FHY is a diversified, closed-end management investment company seeking to provide a high level of current income. As a secondary objective, the fund looks to provide capital growth. It seeks to achieve its investment objectives by investing in a diversified portfolio of below-investment grade and investment grade debt securities, and equity securities that the investment sub-adviser believes offer attractive yield and/or capital appreciation potential. The fund may invest up to 100% of its managed assets in below-investment grade debt securities (commonly referred to as ‘high-yield’ or ‘junk’ bonds).

Vanguard Changes Benchmarks for Funds

Vanguard has announced plans to change benchmarks for three sector funds and their corresponding exchange-traded fund (ETF) shares: Vanguard Telecommunication Services Index Fund, Vanguard Consumer Discretionary Index Fund, and Vanguard Information Technology Index Fund. The changes will be consistent with S&P Dow Jones and MSCI’s planned revisions announced in November 2017 to the funds’ respective target benchmarks under its Global Industry Classification Standards methodology. 


“We’re pleased with MSCI’s changes as we believe the reconstituted benchmarks provide investors with a better representation of the sectors they track,” says Vanguard Chief Investment Officer Greg Davis. “We have determined that these changes and our approach to adopting the new benchmarks are in the best interests of shareholders.”


Vanguard’s Equity Index Group will carefully manage the transition. Beginning in the second quarter of 2018, the funds will track custom transition benchmarks. These interim benchmarks are designed to ensure the changes are implemented in the most transparent, cost-efficient way for the funds’ investors, while also reducing tracking error and mitigating market impact. The funds will track these custom benchmarks until MSCI’s index changes are complete, at which time the funds will revert back to their applicable MSCI benchmarks. 


Vanguard has successfully employed transition benchmarks in the past to execute benchmark changes including the 2016 transition of the Vanguard Emerging Markets Stock Index Fund to the FTSE Emerging Markets All Cap China A Inclusion Index, and Vanguard Developed Markets Index Fund’s 2015 changes to the FTSE Developed All Cap ex US Index benchmark.


The transition to the new benchmarks is not expected to result in material capital gains distributions to shareholders or changes to the funds’ expense ratios.