A press release said that based on the aggregate scores of five components (with 100 points being the maximum), each target-date fund series earns one of five ratings: Top, Above Average, Average, Below Average, or Bottom. Morningstar will review and update the ratings annually.
The five components, according to the announcement, are:
- Examines the fund series’ management team and how well Morningstar thinks they’ll serve shareholders over the long term, and incorporates factors including management tenure, past performance, and research support.
- Considers the criteria used to determine fund managers’ compensation and whether or not the incentive is to deliver strong long-term returns to shareholders. Also assesses the manager’s financial commitment to the fund through direct ownership of shares.
- Assesses the fund board overseeing the target-date series by determining if the fund board is sufficiently independent of the fund advisor and whether or not the board has consistently acted in shareholders’ best interest.
- Evaluates whether fund companies consistently put shareholders’ interests first. Fund firms with industry-leading corporate cultures tend to be forthcoming about their investment successes and failures, and stress long-term returns when marketing their funds to shareholders.
- Examines how well fund companies explain how their target-date funds operate to current or potential shareholders in their publicly available materials.
- Notes any regulatory issues at the fund company within recent years. As a baseline standard, Morningstar assumes that a company should be fully compliant with the law; any regulatory breaches are penalized based on the severity of the infraction.
- Performance – Assesses how well a series of target-date funds has performed historically relative to its peers on a risk-adjusted basis, taking into account the relatively short performance histories of many series, and assigns a score to each target-date fund series based on a comparison to the universe average.
- Portfolio – Calculates a weighted average Morningstar Rating for Funds (the “star rating”) for the underlying holdings in the series to determine the investment quality of the funds.
- Assesses the actual costs investors pay by selecting the lowest-cost share class that has at least 10% of the overall assets in the target-date fund series. The net prospectus expense ratios for that share class are then averaged across all of the funds in the series.
- Assigns score to each target-date fund series based on a comparison to the universe average.
Each research report will contain detailed commentary by a Morningstar fund analyst on all aspects of the scoring, as well as additional analysis of non-scored aspects of target-date funds’ structure and components, Morningstar said.
Reports on participant misconceptions of target-date funds (see Promises They Can’t Keep: Misconceptions about Target-date Funds ) as well as the wide range of equity allocations for different funds (see FRC Target-Date Fund Analysis Shows Wide Range in Equity Allocations ) has led the U.S. Senate (see Senate Committee Takes Aim at Target-Dates ) and the SEC and DoL (see More Details Given on EBSA/SEC Hearing on Target-dates ) to take a more intense look at them.
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