Do investors obtain better results selecting mutual funds through quantitative ratings?

Abstract

ABSTRACT The objective of this paper is to analyse if ratings are reliable tools in selecting mutual funds. Our sample contains the European equity funds rated by Morningstar from 2003 to 2014. Our conclusions support the ability of ratings to predict future performance in the short and medium term. In this sense, we have found that on average, funds with lower ratings have a worse out of sample performance in terms of risk-adjusted measures and annual return. The strongest predictability is observed for one year ahead but is also good for the three-years period. The inclusion of costs and other variables like turnover, age and size, reflect the importance of considering other factors to explain future performance. Finally, the best ratings have a better behaviour in terms of VaR (value at risk) showing that investment in good rated funds can better help to preserve investors’ wealth under unfavourable market conditions.