Star Power: The Effect of Morningstar Ratings on Mutual Fund Flows
Diane Del Guercio, University of Oregon
Paula A. Tkac, Federal Reserve Bank of Atlanta

Morning star, Inc. has been hailed in both academic and practitioner circles as having the most influential rating system in the mutual fund industry. This study investigates Morning star’s influence by estimating the value of a star rating in terms of the asset flow it generates for the typical fund. The authors use event-study methods on a sample of 3,388 domestic equity mutual funds from November 1996 to October 1999 to isolate the “Morning star effect” from other influences on fund flow.

The authors separately study initial rating events, whereby a fund is rated for the first time upon their 36-month anniversary, and rating change events. An initial 5-star rating results in average six-month abnormal flow of $26 million, or 53% above normal expected flow. Following rating changes, they find economically and statistically significant abnormal flow in the expected direction, positive for rating upgrades and negative for rating downgrades. Furthermore, they observe an immediate flow response, suggesting that some investors vigilantly monitor this information and view the rating change as “new” information on fund quality. Overall, the results indicate that Morning star ratings have unique power to affect asset flow. (Accepted Fall 2001.)