Can Morningstar's analysts be the new stars?

Morningstar has introduced a new ratings system called the Analyst Ratings in an effort to improve on their not-at-all-predictive Star Ratings.  They use qualitative factors to rate funds as either Gold, Silver, Bronze, Neutral, or Negative.  Morningstar should be applauded for try to reach beyond their Star Ratings based on past performance, but Analyst Ratings probably won't be any better.

Analyst Rating concerns:

• As the Motley Fool points out in their cleverly-named post on the subject, the analyst ratings may suffer from the same systematic positivity as stock analysts.
• This article from Dan Wiener at InvestorPlace points out several inconsistencies in the ratings, such as rating two Vanguard funds that follow the S&P 500 differently.
• The Wall Street Journal points out that the analyst picks and pans, on which the new Analyst Ratings are based, have a pretty poor record.  Only 46% of picks beat their index benchmark.
• They started by rating only about 350 funds, and hope to expand to about 1,500.  Given that there are over 7,000 US mutual funds, it is unclear how they will decide what to rate in a way that is fair.

Analyst Ratings is shaping up to be just another way sell past performance analysis.

More DOL investigations - this time with irony!

Following up on our recent post titled "Investigations into improper advice" about the increasing number Department of Labor investigations into breaches of fiduciary duty, we found an interesting Businessweek article by Anthony Effinger.  The article tells the story of an independent fiduciary being sued by retirement plans for breach of fiduciary duty.  Sounds run-of-the-mill until you see that the independent fiduciary had said, "The fiduciary duty is the highest duty known to the law," when testifying a few years earlier before a congressional committee.

This story reminds us of several facts for 401(k) plan sponsors:

1. Hiring an independent fiduciary does not necessarily shield you from liability.
2. You shouldn't blindly trust people just because (or maybe especially if) they've testified before Congress.
3. Even if you hire outside help, it is a good idea to be informed.

Good data can help you — trust but verify.

It's so you don't get sued

In a post titled, "Why 401(k) Plan Sponsors Should Make Sure Education and Advice is Offered To Their Participants", Ari Rosenbaum points out:

"Studies have shown that the use of investment education and advice has increased the rate of return for participants.  So plan sponsors who want to boost employee morale, one way is to help increase the retirement savings of their employees because better informed participants will make better investment decisions and net better returns."

Education (including, we might add, good quality information about the mutual funds offered) helps make employees happier about their retirement plan, but Rosenbaum's scarier point is, "Offering education and advice goes a long way in satisfying the fiduciary process under ERISA §404(c) to limit a plan sponsor’s liability."

Occupy mutual funds?

Tom Petruno recently wrote an article in the LA Times where he wonders why the anger towards banks has not spilled over to mutual funds.  He brings up the question of how many mutual funds could truly justify their fees.

We think this is a very good point.  Take a key example of mutual funds systematically overcharging: closet indexing.  Let's do a back-of-the-envelope calculation to get at the scale of this problem.