Diane Del Guercio and Paula A. Tkac
Working Paper 2001-15
August 2001

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

We separately study initial rating events, whereby a fund is rated for the first time on its 36-month anniversary, and rating change events. An initial five-star rating results in average six-month abnormal flow of $26 million, or 53 percent above normal expected flow. Following rating changes, we find economically and statistically significant abnormal flow in the expected direction, positive for rating upgrades and negative for rating downgrades. Furthermore, we 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, our results indicate that Morningstar ratings have unique power to affect asset flow.

JEL classification: G11, G14, G20

Key words: mutual funds, asset flow, event-study

We gratefully acknowledge research support from a grant from the Institute for Quantitative Research in Finance (Q-Group). We thank John Rekenthaler, Director of Research at Morningstar, Inc., for providing data, and Paul Gozali of Morningstar’s research department for answering numerous data questions. We thank Robert Battalio, John Chalmers, Larry Dann, Laura Field, Aditya Kaul, Elizabeth Odders-White, Tracie Woidtke, and seminar participants at the 2000 Pacific Northwest Finance Conference and the Atlanta Fed Brown Bag series for helpful comments. The views expressed here are the authors’ and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors’ responsibility.

Please address questions regarding content to Diane Del Guercio, Lundquist College of Business, University of Oregon, Eugene, OR 97403-1208, 541-346-5179, dianedg@oregon.uoregon.edu or Paula A. Tkac, Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree St. NE, Atlanta, GA 30309-4470, 404-498-8813, Paula.Tkac@atl.frb.org.