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Margaret Kirch Cohenmargaret.cohen@morningstar.com
Morningstar Introduces Fiduciary Grade for Mutual Funds to Help Investors Identify Funds that Represent Industry Best Practices

CHICAGO, August 24, 2004 – Morningstar, Inc., a leading provider of independent investment research, today introduced a Fiduciary Grade* for mutual funds to help investors further research, identify, and compare fund managers and fund companies that do a good job -- or a poor job -- of aligning their interests with those of fund shareholders.  Morningstar fund analysts created the grades to help investors assess the intangible traits of a fund -- including regulatory issues, the quality of a fund board, management incentives, fees, and the firm's corporate culture -- that can make the difference between a great investment and one to avoid.

“Many investors begin their search for a fund by focusing on measurable, tangible factors such as performance and volatility, but it’s equally important to consider the intangibles associated with making an investment decision,” said Kunal Kapoor, director of mutual fund analysis for Morningstar.  “Our analysts have long considered these less-tangible factors in an effort to help investors determine which fund companies do the best job of safeguarding their interests.  We’ve included this type of information in our written analyst commentaries for years, and now we’re taking the next step and presenting our research in a format that will make it easier for investors to compare funds’ corporate governance track records and identify the firms that embody the industry’s best practices.”

Initially, Morningstar is assigning letter grades from A (best) to F (worst) to 500 of the largest mutual funds.  During the coming months, they will assign Fiduciary Grades to approximately 1,500 more funds. The new Fiduciary Grades are based on information compiled from public filings, responses to a detailed survey Morningstar sent to each fund company, and Morningstar fund analyst research.  

Components of the new Morningstar Fiduciary Grade for funds:

Regulatory Issues
Morningstar fund analysts examine any regulatory issues at the fund company during the past three years.  For any infraction indicating the advisor may not have upheld its fiduciary duty to fund shareholders, Morningstar reviews the remedies in place, as well as the firm’s commitment to instituting meaningful reform.

Board Quality
As envisioned by the Investment Company Act of 1940, funds are corporations, and fund boards are in place to act as the vigorous representatives of fund shareholders.  To evaluate whether a fund’s directors have delivered on that requirement, analysts examine whether directors are truly independent, oversee a manageable number of funds, have meaningful investments in the fund(s) they oversee, and take action to fix troubled funds, such as removing underperforming managers.

Manager Incentives
Morningstar analysts use proprietary survey information to determine whether a manager holds a significant investment in the fund he or she runs (defined as one third of his or her liquid net worth).  If it’s not appropriate for a manager to make such an investment (for example, a manager who oversees a short-term bond fund), then Morningstar assesses whether the manager has at least one third of his or her liquid net worth in other funds at the same firm.  In addition, Morningstar analysts evaluate the compensation structure at each fund to determine whether incentives properly align management's interests with those of fund shareholders.  Specifically, analysts consider whether management compensation is based on short- or long-term performance, and/or pretax or aftertax returns.  Analysts also consider whether asset growth is a factor in computing a manager’s compensation.

Analysts assess whether the fund’s expense ratio is below average for its share class within its Morningstar Category.  They also determine whether fees decrease as assets grow and whether large or closed funds continue to charge 12b-1 fees.

Corporate Culture
Analysts consider a wide range of criteria to gauge how seriously a fund company takes its fiduciary duty to fund shareholders. Factors include the strength of shareholder communications; prudence of advertising and new fund launches, if any; use of redemption fees to discourage rapid trading; the firm's policy for closing funds and track record of doing so; retention of key personnel; and participation in so-called "soft-dollar" arrangements which mask costs that potentially erode fund returns.

The Grading Process
Each component is worth a maximum of two points, for a total of 10 possible points. Each component score corresponds to one of the following qualitative terms:

Excellent: 2 points
Good: 1.5 points
Fair: 1 point
Poor: 0.5 point
Very poor: Zero points or fewer (For the Regulatory Issues component only, analysts may assign up to two negative points for serious breaches of fiduciary duty.)

The overall Fiduciary Grade is based on the sum of the five component scores as follows:
A: 9 – 10 points
B: 7 – 8.5 points
C: 5 – 6.5 points
D: 3 – 4.5 points
F: 2.5 points or fewer

Both the individual component scores and the overall Fiduciary Grade for each fund can be found in the fund reports available to Premium Members of Morningstar.com, the company’s Web site for investors.  The overall Fiduciary Grade will also be added to reports published in the twice-monthly newsletter Morningstar® Mutual FundsTM, and will be one of the topics regularly discussed in the “Fund Company Watch” column in the monthly newsletter Morningstar® FundInvestorTM.

The methodology for the Fiduciary Grade for funds is completely different from the Morningstar RatingTM for funds (the “star rating”), and the new Fiduciary Grade has no impact on a fund’s star rating.  The Morningstar Rating is a quantitative assessment of a fund’s past performance – both return and risk – as measured from 1 to 5 stars.  The Fiduciary Grade is determined using some quantitative measures, but it is primarily based on qualitative information gathered by Morningstar fund analysts.

For Morningstar’s “Fund Spy” commentary on the Fiduciary Grade, go to:

For a comprehensive review of the Fiduciary Grade methodology, go to:

* As of Feb. 7, 2005, the grade is now called Stewardship Grade for funds.

About Morningstar, Inc.
Morningstar, Inc. is a leading provider of independent investment research in the United States and in major international markets.  The company offers an extensive line of Internet, software, and print-based products and services for individuals, financial advisors, and institutions.  Morningstar tracks more than 100,000 investment offerings, including stocks, mutual funds, and similar vehicles.  The company has operations in 16 countries.

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