Do Mutual Fund Ratings Provide Valuable Information for Retail Investors? : Empirical Evidence on Ratings Non-Persistence and the Risk of Mutual Fund Closure

Retail investors use information provided by mutual fund rating agencies to make investment decisions. Using hand-collected data on Morningstar’s mutual fund ratings we examine the rating migration and closure risk of mutual funds from 2005 to 2012. We differentiate between buy-and-hold investment strategies and dynamic investment strategies. To assess the information content of mutual fund ratings for buy-and-hold investment strategies, we determine the rating migration based on the first and the last mutual fund rating during two-, four-, six-, and eight-year horizons. With respect to dynamic investment strategies, we calculate the number of rating changes per fund during these time horizons on a monthly basis. We find that mutual fund rating persistence is low or even inexistent in particular during longer time periods. Only for lower-rated funds the rating appears to indicate higher risk of fund closure. In addition, mutual funds face a large number of up to 38 monthly rating changes in the eight-year window. Overall, due to the extensive rating migration and the high number of monthly rating changes, we conclude that retail investors barely benefit from using mutual fund ratings.