Selectivity, Market Timing and the Morningstar Star-Rating System

This paper evaluates the Morningstar mutual fund ranking system. We \u85nd that indeed higher Morningstar ratings are associated with higher returns on the portfolios including respectively ve-, four-, three-, two- and one-star funds only (STAR5 to STAR1). We then perform an unconditional and conditional portfolio performance evaluation. In both cases the evidence suggests that the better performance of the STAR3, STAR4 and STAR5 categories reects superior stock selection rather than market timing abilities. Overall, the implication for the Morningstar ranking system is that this is most e¤ective in identifying the worst-performing funds (STAR1 or STAR2) rather than the best-performing ones