Regard All Investment Ratings Doubtfully

The message:

When it comes to investing, noone—including the highlyregarded mutual fund-ratingcompany Morningstar (www.morningstar.com)—is always right. Caught offguard when several of its highly ratedfunds were named in the recent fundscandals, the company is taking steps toavoid being placed in such an embarrassingsituation. If you sitback and simply rely on companies likeMorningstar to be unerring, chances are,you're going to get burned.

Take New Approaches

Wall

Street Journal

To its credit, Morningstar is makingsome changes. According to a report, Morningstarrecently announced plans to introduce aset of corporate governance ratings thatfocus on management practices of fundcompanies rather than performance.Funds will be graded based on boardindependence and pay, expenses, corporateculture, regulatory issues, and fundmanager compensation. Morningstarsaid it also plans to alert investors whena fund is overloaded in one area of themarket, and has published articles explainingthat even funds rated with fivestars might not be suitable for certaininvestors because of volatile returns.

So, does that mean you can now accepteverything the fund-rating giant says asbeing unerring and reliable? Not exactly.

Journal

According to the article,Morningstar recently announced itsplans to go public. That raises numerousquestions. For example, will the company'sanalysts be able to remain objectivewhen the funds they rate own shares inMorningstar? And with a stock price tobe concerned about, will the company'sexecutives still be willing to go head-to-headwith Wall Street?

Journal

In addition, Jonathan Clements, therespected columnist writing in a separatearticle, notes, "Morningstar hasgiven the go-ahead to invest again withfirms" that have "settled with regulatorsand cleaned up their operations." But,Clements questions, why would anyonewant to invest with a scandal-taintedfund company when there are so manyother companies with long, admirablehistories to choose from?

Do Your Own Research

Fortune

In a recent article, investmentadvisor Jerry Tweddell details some ofthe key characteristics of the 25 best-performingdiversified US stock funds in2003. Tweddell has done this exercise forthe past 5 years and back-tested it 5years before that.

Tweddell says that the reason for studyingthese funds is "to identify desirablecharacteristics to assist in selecting futureoutperformers." In other words, use thecommon characteristics that made thesefunds successful to analyze future winners.

He found that four key characteristicswere a common thread among the majorityof the 25 top-performing diversifiedfunds: being new (the average age was 5 1/2years), being small cap (80% were smallcaps), having small assets, and having independentmoney managers (ie, their solemission is to manage investments).

Tweddell warns that these criteria arestructural only, and that fund managersare the key to driving performance.Tweddell writes, "Funds combiningdesirable structural and managerial characteristicsoffer above-average odds ofsuperior performance."

Finding a clean fund that will performwell is still difficult. But if you go for a testdrive, kick the tires, and look under thehood as opposed to just reading an informationalbrochure, you're likely to make awiser investment decision.