Morningstar Risk- Closed-end Funds

Listed for three, five, and ten years, a statistic that evaluates the fund’s downside volatility relative to that of others in its broad asset class. To calculate the Morningstar Risk score, we plot fund's monthly returns in relation to T-bill returns. We add up the amounts by which the fund fell short of the Treasury Bill’s return and divide the result by the total number of months in the rating period. This number is then compared with those of other funds in the same broad asset class. The resulting risk score expresses how risky the fund is, relative to the average fund in its asset class. The average risk score for the fund’s asset class is set equal to 1.00; thus a Morningstar risk score of 1.35 for a taxable-bond fund reveals that the fund has been 35% riskier than the average taxable-bond fund for the period considered. The four broad asset classes are domestic stock, international stock, taxable bond, and municipal bond.

Benefits

Morningstar uses a proprietary risk measure that operates differently from traditional risk measures, such as beta and standard deviation, which see both greater-than and less-than expected returns as added volatility. Morningstar believes that most investors' greatest fear is losing money--defined as underperforming the risk-free rate an investor can earn from the 90-day Treasury Bill--so our risk measure focuses only that downside risk. Note that Morningstar does not rate any fund that has less than three years of performance history.

Origin

Morningstar generates this statistic in-house.

For the Pros

Here’s an example of how we would compute the Morningstar Risk measure over a six-month period:

Month

Fund Return

T-bill Return

Underperformance (Loss)

1

3.0

0.5

--

2

-1.5

0.5

2.0

3

0.5

0.6

0.1

4

4.0

0.7

--

5

-2.0

0.5

2.5

6

3.0

0.5

--

 

 

 

Total = 4.6

Total loss/Total # of months  = 4.6/6 = .77 (Average monthly performance)

Morningstar Risk = avg. monthly underperformance/avg. monthly performance of the investment class

 

Investors should note that this measure is purely historical and not predictive.