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Margaret Kirch Cohenmargaret.cohen@morningstar.com
Morningstar Releases Study Findings: Holdings-Based Style Analysis Superior to Returns-Based Style Analysis

CHICAGO, Mar 13, 2002 – Morningstar, Inc. today announced the results of a groundbreaking study of the relative merits of the two commonly used methods of measuring a portfolio's investment style: holdings-based style analysis and returns-based style analysis. Contrary to common perception, the study revealed that, on average, holdings-based style analysis provides more accurate results than returns-based style analysis.

Returns-based style analysis, a method for determining the style of an investment portfolio by analyzing its return performance, grew in popularity in the 1980s. It was introduced as an alternative to holdings-based analysis, which determines investment style by examining the actual securities held in a portfolio. Returns-based analysis is considered especially useful, or even preferable, in situations where current portfolio information is not available.

The Morningstar study, the first systematic, empirical direct comparison of the results obtained by these two methods, was authored by Michele Gambera, Ph.D., of the firm's research department, and John Rekenthaler, CFA, and Josh Charlson, Ph.D., of the firm's online investment advice business unit.

"Returns-based style analysis has been a staple of the investment industry for more than a decade, yet no one has ever systematically measured how well its results compare with those of fundamental portfolio analysis," Rekenthaler said. "Our study revealed that in most cases, holdings-based analysis of the most recent available portfolio--or even one that is several years old--provides a better measure of a mutual fund's current investment style than does returns-based analysis."

Specifically, the Morningstar study examined more than 500 domestic-equity mutual funds for which complete portfolio information was available from 1997 to 2000. Holdings-based analysis of the year-end 2000 portfolios was used to establish baseline portfolio compositions, as expressed as percentages of nine distinct asset classes. Returns-based style analysis was then used to determine percentage breakdowns for each portfolio using the same asset classes. These results were compared with those obtained from holdings-based analysis of portfolios from 1999, 1998, and 1997. On average, the holdings-based analysis of the older fund portfolios produced asset class percentages that were closer to those of each fund's current portfolio than did returns-based analysis.

Dr. Gambera added, "Returns-based style analysis has value in certain situations, especially when no portfolio holdings information is available. But if accuracy is the primary goal, holdings-based analysis remains our best tool for sizing up a mutual fund portfolio."

To read the complete study, or to download a PDF version, visit https://cf.morningstar.com/login/Research_Paper_1201.pdf

About Morningstar, Inc.
Chicago-based Morningstar, Inc. is a global investment research firm, offering an extensive line of print, software, and Internet-based products and services for individuals, financial advisors, institutions, and the media. The company is a trusted source for investment information, data, and analysis of stocks, mutual funds, exchange-traded funds, closed-end funds, and variable annuity/life subaccounts.

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