Key Takeaways
- Rates fund downside risk relative to peers.
- Uses a five-level scale from Low to High.
- Focuses on historical negative return volatility.
- Penalizes losses more than equivalent gains.
What is Morningstar Risk Rating?
The Morningstar Risk Rating evaluates the downside volatility of mutual funds and ETFs relative to their peers, categorizing risk on a five-level scale from Low to High. Unlike forward-looking metrics, this rating focuses on historical monthly return variations to help you understand the risk profile of your investments.
This rating is distinct from Morningstar’s Uncertainty Rating, which assesses stocks' cash flow predictability, making it a specialized tool for fund risk assessment.
Key Characteristics
Morningstar Risk Rating highlights risk through a backward-looking lens with these key features:
- Risk Levels: Five categories—Low, Below Average, Average, Above Average, and High—rank funds within their peer groups.
- Downside Focus: Emphasizes negative return volatility by applying a risk penalty that reflects investors’ greater sensitivity to losses.
- Category-Based Comparison: Funds are evaluated against similar peers, ensuring relevant risk assessment within sectors or styles.
- Minimum Age Requirement: Only funds older than three years qualify, with ratings updated monthly for accuracy.
- Integration with Star Ratings: Works alongside star ratings by adjusting for risk in performance evaluations.
How It Works
The rating calculates downside risk by assessing monthly returns and applying a utility-based risk penalty that weighs losses more heavily than gains. This approach aligns with investor behavior that penalizes volatility on the downside.
Funds are ranked within their respective categories using weighted data from 3-, 5-, and 10-year return periods, with older data weighted more heavily for stability. This method accounts for systematic factors like factor exposures and idiosyncratic risks, ensuring a comprehensive risk profile.
Examples and Use Cases
Understanding Morningstar Risk Ratings can guide your portfolio decisions, particularly when comparing funds or selecting ETFs from categories like low-cost or dividend-focused options.
- Airlines: When evaluating sector risk, companies such as Delta may exhibit different risk profiles compared to peers, influencing fund volatility assessments.
- Low-Cost Index Funds: Incorporating ratings into your analysis complements insights from resources like our best low-cost index funds guide for cost-efficient portfolio construction.
- Dividend ETFs: Risk ratings help identify stable income sources as highlighted in the best dividend ETFs guide, balancing yield and downside risk.
Important Considerations
Morningstar Risk Ratings are relative and backward-looking, so they may not predict future volatility or risks for new funds. Keep in mind the rating depends on category groupings, which can vary in risk profiles themselves.
Additionally, the rating excludes total volatility measures like tail risk and uses R-squared statistics to ensure meaningful risk attribution, but lower data quality can affect accuracy.
Final Words
Morningstar Risk Ratings provide a clear, historical snapshot of a fund’s downside volatility relative to peers, helping you gauge past risk levels. Use these ratings alongside other metrics to compare funds and determine if their risk profile fits your investment goals before committing capital.
Frequently Asked Questions
Morningstar Risk Rating evaluates the past downside risk of mutual funds and ETFs by measuring how their returns vary negatively compared to peers. It uses a five-level scale from Low to High to help investors understand the relative riskiness of a fund within its category.
The rating is based on historical monthly returns, focusing on downside volatility using a risk penalty that weighs losses more heavily than gains. Funds are ranked within their categories, with weights on 10-, 5-, and 3-year periods to provide a comprehensive risk assessment.
The scale includes five levels: Low, Below Average, Average, Above Average, and High risk. These levels represent how a fund's downside volatility compares to peers, with Low risk indicating the least downside volatility and High risk indicating the most.
Morningstar Risk Rating assesses past downside risk for funds and ETFs, while Uncertainty Rating is a forward-looking measure of cash flow predictability for stocks. The Uncertainty Rating uses levels like Low to Extreme to indicate how predictable a stock’s future cash flows are.
Investors typically dislike losses more than they value equivalent gains, so Morningstar applies a risk penalty to downward return variations. This approach aligns with expected utility theory and better reflects investors’ real risk aversion.
No, the rating compares funds only within their specific categories, such as value-growth or sector groups, to ensure an apples-to-apples risk comparison based on similar investment styles and objectives.
No, this rating is backward-looking and based solely on historical return data. It does not incorporate analyst predictions or forward-looking estimates, which are part of other Morningstar metrics like star ratings or Uncertainty Ratings.
Morningstar Risk Rating is designed for mutual funds and ETFs, focusing on their downside return volatility. It is not applied to individual stocks or entire portfolios, which have different risk assessment measures.
