PLANADVISER - September/October 2021 - 13

fied BBB-rated fund could potentially show a higher yield and
more upside potential than its correctly classified BB-peers.
The authors also maintain that " misclassified funds receive
significantly more Morningstar stars than [do] other funds. "
In the retirement planning world, star ratings matter.
Plan advisers interviewed here say they frequently use Morningstar's
analyses, including star ratings, when considering
which bond funds to propose for a retirement plan's lineup.
Other research shows participants tend to rely " blindly " on
such ratings when evaluating their plan's bond funds.
The working paper attracted attention after its publication,
and the authors and Morningstar's research staff held
a conference call to discuss the findings. Morningstar subsequently
published a series of critiques, which the authors
rebutted. Their disagreements remained unresolved, as the
paper's final draft was published in August's peer-reviewed
" Journal of Finance. "
Self-Reported Data
Bond funds often hold hundreds of securities with a wide
range of covenants, maturity dates, yields and other features,
even among bonds from the same issuer. Additionally, creditrating
agencies can differ on a security's creditworthiness,
assuming a bond is rated at all.
The key point for the authors was that Morningstar asks
each bond fund it tracks to provide a monthly summary
report of its holdings-a system, they say, the company
relies on to rate the funds and that can invite abuse. Funds
hence misclassified, they add, can charge significantly higher
expenses and attract more investor flows.
Jeff Westergaard, Morningstar's fixed-income data
director, says he is confident in the data's quality, referring to
the " tens of thousands of these surveys " they receive and the
comprehensive data each collects.
Morningstar published responses in November and
December 2019, asserting the authors incorrectly presumed
all self-reported unrated bonds were low quality and possibly
misunderstood how Morningstar classifies funds. The
company uses the categories to peer-group, rank and assign
ratings to funds, while the authors' sole focus was on the
fixed-income style-box assignments.
" Once we've assigned funds to Morningstar Categories,
we can compare and rank them on measures such as past
performance. To assign star rating, we rank funds' trailing
risk-adjusted returns against those of other funds in their
Morningstar Category (the Morningstar Risk-Adjusted Return
Rank), " the response said.
According
to Morningstar's December
reply,
the
company had asked the authors to list the funds they
considered misclassified and to classify them properly, but
the authors said they could not, " as they'd defined 'misclassification'
based on funds' style box, not Morningstar Category,
assignments. "
Morningstar's published conclusion is, " We have found no
evidence that bond funds have been incorrectly assigned to
Morningstar Categories in the way the authors allege. "
As of early September, Morningstar still lacked a clear idea
of what data or methodology the authors used to reach their
conclusions, Westergaard says. " We did ask them to share
this, and they declined to do so. " The authors' published
response: " We are using Morningstar's data, along with
Morningstar's published formulas for calculating all of the
weightings and classifications in the paper. "
Two of the authors agreed to discuss their findings, with
PLANADVISER, but subsequent messages with specific
questions were unanswered by deadline. -Ed McCarthy
talking points
Plain Speak
Advisers might keep in mind that when asked
to choose the term that fits each definition given
below, this is what plan participants said:
A person or organization that acts for you to
manage your finances, putting your interest first
and having a duty to preserve good faith and trust.
l Certified financial adviser
l Financial professional who must legally
act in your best interest
l Fiduciary
l Registered investment adviser
l Fee only adviser
9%
15%
12%
30%
The product of collecting information from multiple
financial accounts that includes both assets and
liabilities.
7%
l Complete financial picture
l Consolidated financial view
l Total net worth calculation
l Seeing all your accounts in one place
l Account aggregation
l Holistic financial view
Source: Empower, " Less Jargon, More Clarity "
18%
10%
19%
25%
21%
33%
planadviser.com September-October 2021 | 13
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PLANADVISER - September/October 2021

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