Seek Out a Second Opinion in the Ratings Game

RUSS WILES, a financial writer for the Arizona Republic, specializes in mutual funds

They might not disagree as often or as loudly as Siskel and Ebert, but the two major mutual fund evaluation services appear to be giving out different ratings more often than not.

An analysis of more than 200 funds graded by Morningstar and Value Line, based on information available in early May, showed that the two were in agreement on just 43% of their picks.

If you're an investor who bases buy and sell decisions on a fund's rating, the implication seems clear enough: Get a second opinion.

You should also be wary of fund advertisements or shareholder literature that cites one service's rating but not the other's. A growing list of fund groups have been using ratings in some ads.

Most of these advertised references come from Morningstar, which has been grading funds for about a decade--since 1986 in its flagship publication, Morningstar Mutual Funds.

Value Line has more than 50 years' experience evaluating individual stocks, but its Mutual Fund Survey didn't premiere until last year.

Both Morningstar Mutual Funds and the Value Line Mutual Fund Survey are notebook-bound publications through which investors receive a new installment of fund evaluations every couple of weeks.

Morningstar also offers software products for analyzing mutual funds on computer, as well as a monthly newsletter called 5 Star Investor, which profiles 500 favored funds for $65 a year.

Value Line hasn't yet unveiled any such products but is considering doing so, Publisher Steve Savage says.

In fairness, Morningstar and Value Line usually don't disagree sharply on a particular fund. They both make use of a five-point scale to grade risk-adjusted performance, and most of the discrepancies are only by one notch.

For example, Morningstar gives an above-average ranking of four stars to the Investment Co. of America, the nation's second-largest mutual fund (behind Fidelity Magellan). Value Line gives it a neutral rating of three.

Of the 25 biggest stock portfolios, only three have been given significantly different gradings by the two services. Both the Janus Fund and 20th Century Ultra enjoy Morningstar's top honor, a five-star rating, but they get only three from Value Line. Washington Mutual Investors gets an above-average mark from Morningstar but a below-average grade from Value Line.

Similarly, only three of the 25 biggest bond funds have significantly different ratings.

It's not surprising that the two systems deviate somewhat, considering they derive their numbers in different fashions. Morningstar calculates its total-return figures by weighting performance over three periods--10 years, five years and three years, in order of importance. Value Line, by contrast, looks only at the five-year numbers.

Both systems, it should be noted, can be misleading if a fund has recently lost the portfolio manager who established its track record.

Another difference deals with the way the sales charge, or load, is handled. Morningstar subtracts any sales charge from performance; Value Line doesn't.

To measure volatility, Morningstar uses a proprietary method that measures how well a fund fared compared to its peers and the "risk-free" return available on Treasury bills.

"Our system is a bit more tilted to favor the lower-risk funds," says John Rekenthaler, editor of Morningstar Mutual Funds. The rationale: Most investors are more worried about losing money than they are about upside fluctuations.

Value Line, by contrast, bases its risk measure on "standard deviation," a widely accepted yardstick that measures variability--up and down--in a fund's returns.

Notably, Morningstar in late April modified its methodology a bit, which has helped narrow the rating differential with Value Line slightly. A look at the same 200-plus funds using information available in early April showed the two services agreed on 40% of their ratings at that time.

Using another yardstick, the two services had differed by an average of 0.86 of a rating unit (Value Line doesn't use stars), but this gap has since narrowed to 0.62, Savage says.

This might be more detail than you want to know. The main point is that you should recognize that a single fund can get two different ratings, depending on which company is evaluating it. Also, ratings from either service can change over time, sometimes dramatically. Perhaps most important: Ratings describe past performance, not future results.

Consequently, Value Line and Morningstar caution investors not to place too much emphasis on a fund's rating, but rather to use it as an initial screening.

Digging beyond the ratings, investors will find a lot of similar information in the way both services evaluate funds. Both offer plenty of facts on performance, loads, other expenses, portfolio holdings, addresses, phone numbers and much more.

Among the differences, Value Line's survey ((800) 284-7607) shows how a fund fared during the most recent bull and bear markets. It also lists how a load fund's sales charge will decline at certain commission break-points, and it gives an illustration of how dollar-cost averaging would have worked with the fund.

Value Line costs less, $295 for an annual subscription compared to $395 for its rival, and it covers more funds, 2,000 to 1,250. (Morningstar's computer products track 3,400 portfolios, however.)

Morningstar Mutual Funds ((800) 876-5005), in turn, also has some advantages. It shows load-adjusted percentage returns, lists any states in which a fund can't be purchased and grades management companies based on the quality of their shareholder reports.

In addition, Morningstar provides quarterly total-return figures, which give more insight on a fund's volatility than the annual numbers alone. Morningstar's reports are on whiter paper with less bold type--easier on the eye.

Finally, Morningstar claims the quality of its written fund critiques is better and has accused Value Line of plagiarizing some reports--a charge Savage denies.

Look for continuing rivalry between these two rating services, both of which provide a quantum leap of improvement compared to what's found in the typical mutual fund prospectus.


The Investment Company Institute is the national trade organization for more than just open- and closed-end mutual funds and their sponsors. It also represents companies that put together unit investment trusts.

And to prove it, the ICI has come out with a free eight-page booklet that explains the basics of these unmanaged portfolios. It can be ordered by writing to the Investment Company Institute, 1401 H St., N.W., Washington, DC 20005.

Ratings Wrinkles

Investors who want help selecting among mutual funds can consult either Morningstar or Value Line for help. Both firms offer publications that grade funds on a five-point scale for risk-adjusted performance.

But because the two services use somewhat different measures for both performance and risk, their overall ratings often vary. The discrepancies can be fairly wide in some cases, as in the following examples, which include six of the largest stock and bond funds available.

Value Line Morningstar Fund Type rating rating Janus Fund Growth stock Average Highest Prudential High-Yield B Bond Highest Average 20th Century Ultra Growth stock Average Highest Vanguard Fixed Long-Term Corp Govt. bond Average Highest Van Kampen Merritt Govt. A Mortgage bond Lowest Average Washington Mutual Investors Growth & income Below avg. Above avg.

Note: The above list is based on ratings that were available as of early May.

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