Mutual fund stewardship grades

In 2004, Morningstar introduced stewardship grades for mutual funds and stocks as a response to the early 2003 late trading and market timing mutual fund scandals. The firm revised its grading methodology in 2007.

In 2004, John Bogle introduced the notion of grading mutual fund companies according to the stewardship of asset management in a keynote speech before the American Institute of Certified Public Accountants, Personal Financial Planning Conference. Bogle termed his grading metric the Stewardship Quotient. . Bogle supplied an expanded version of the Stewardship Quotient in his 2012 book, Clash of the Cultures.

Stewardship grades are meant to give investors an indication of whether the interests of a management company and fund manager are aligned with those of the fund's shareholders. Stewardship grades combine both quantitative and qualitative judgements in assessing a mutual fund company's adherence to fiduciary standards.

Morningstar stewardship grades
Morningstar provides stewardship grades for mutual funds and stock companies.

Methodology
Morningstar stewardship grades are assessed across five categories. Each component is given a range of possible points. The points are then tallied and given a lettered grade.

The composite point tallies are then ranked according to the following scale:

Morningstar measures each fund's score against it peers. Morningstar categories have been combined where appropriate to form 37 comparison groups of funds that invest in similar asset types. Morningstar admits that its coverage of funds contains selection bias due to its emphasis on widely-held funds. Quoting Morningstar: "Many of the industry’s largest funds and largest fund companies got that way because they’ve been decent stewards of fundholders’ capital."

In the 2011 Morningstar Global Investor Experience Study the U.S. is given an overall A rating, with an C+ rating for regulation and taxes:

What stewardship grades reveal
A 2011 Morningstar study of its stewardship grades offers the following conclusions:
 * Funds with failing stewardship grades were very often killed off by merger or liquidation. Funds earning A’s almost always survived.
 * In the years after the grades were issued, funds earning high grades were very likely to garner Morningstar Ratings of at least 3 stars, demonstrating that on a risk-adjusted basis, the funds kept up with or surpassed peer funds with similar strategies.
 * The top-graded funds had calendar-year category and investor returns that edged past peers.

In a 2011 study, Gottesman and Morey take issue with the Morningstar conclusions. Examining the corporate culture standard (the highest weighted Morningstar standard) the authors come to the following conclusions:


 * High stewardship graded firms were strongly associated with low fees, long manager tenure, low turnover, and fund survival.
 * However, high stewardship graded funds provided no consistent investment performance advantage over lower rated funds.
 * A strong corporate culture may insulate a mutual fund from scandal but will not result in the mutual fund outperforming the market.

Morningstar responded to Gottesman and Morey:
 * Gottesman and Morey examine U.S. stock funds; the Morningstar stewardship grades include international funds.
 * Gottesman and Morey rank stewardship graded mutual funds in relation to Sharpe ratios; Morningstar rates the funds according to peer groups.
 * Gotteman and Morey deal with fund closures by replacing killed funds with replacement funds; Morningstar does not use replacement funds.

Morningstar stewardship grades for Canadian funds
Morningstar launched stewardship grades for Canadian funds in June 2010. The first publication of stewardship grades was marked by controversy, as Investment Funds Institute of Canada (IFIC) president and CEO Joanne De Laurentiis tried to discourage Morningstar from releasing the report by sending member firms a copy of a letter sent to Morningstar Inc. president Don Phillips. The letter expressed the following complaints:


 * Morningstar’s view is that “firms that believe in advice and deliver investment products through the advisors should be penalized.”
 * The study is qualitative and subjective.
 * The disclosure of fund manager compensation is not required by Canadian regulation.
 * Stewardship Grades have no predictive value to investors.

Morningstar issued a quick rebuttal and published its report.

Methodology
Morningstar's Canadian stewardship grading system is similar to that used in the U.S. market. The system includes four factors:


 * Corporate Culture : maximum score is 5 points
 * Manager Incentives: maximum score is 3 points
 * Fees: maximum score is 2 points
 * Regulatory History: maximum score is 0 points, and the lowest possible score is -2 points.

The letter grading system is similar to the U.S.system:

In the 2011 Morningstar Global Investor Experience Study Canada is given an overall C+ rating, with an F rating for fees and expenses:

Morningstar Global Investor Experience Study
Morningstar also has initiated reports of investor experience in twenty two countries in North America, Europe, Asia, and Africa. The Global Investor Experience Study grades national markets in four categories:
 * Regulation and Taxation
 * Disclosure
 * Fees and Expenses
 * Sales and Media

The first study was issued in 2009. The second study was issued in 2011. The following table provides the 2011 grading on national markets:

Bogle stewardship quotient
John Bogle, throughout his professional and literary careers, has stressed the need for the investment management industry to practice higher fiduciary standards. In books and papers he has been a severe critic of mutual fund business practices. Bogle has argued for the need of a legislative fiduciary standard governing the investment industry. Among Bogle's criticisms:


 * The investment industry imposes high costs on investors through high management costs, and excessive turnover of equity investments.
 * The mutual fund industry creates too many new and speculative funds, and practices short term speculation as opposed to long term investment. This conduct has encouraged investors to likewise increase their turnover of fund shares.
 * The mutual fund industry has moved from being predominately managed by the values of a profession to one predominately run by the values of a business. The industry has increasingly undergone a transition to conglomerate ownership of mutual fund companies, to the detriment of investment performance.
 * The mutual fund industry fails to properly exercise its oversight role as owners of businesses.

Methodology
John Bogle's updated Stewardship Quotient sets up 15 mutual fund standards for investor consideration. Each standard has four conditions which are graded (3 points, 2 points, one point, and zero points). The points are summed and divided by 15. This result is then multiplied by 100 to arrive at a fiduciary score. Thus, the highest grade a mutual fund company can earn is 300 points.

Academic papers

 * Haslem, John A., Identifying Mutual Fund Stewardship (April 22, 2008).
 * Gottesman, Aron A. and Morey, Matthew R.,Mutual Fund Corporate Culture and Performance (June 1, 2011).
 * Morningstar Challenges Study That Questions Its Ratings, WSJ April 13, 2012.


 * Wellman, Jay W. and Zhou, Jian, Corporate Governance and Mutual Fund Performance: A First Look at the Morningstar Stewardship Grades (April 22, 2007)