Morningstar Ratings
Morningstar Rating
Morningstar rates subaccounts from one to five stars based on how well they've performed (after adjusting for risk and accounting for sales charges) in comparison to similar subaccounts. Within each Morningstar Category, the top 10% of subaccounts receive five stars and the bottom 10% receive one star. Subaccounts are rated for up to three time periods—three-, five-, and 10 years—and these ratings are combined to produce an overall rating. Subaccounts with less than three years of history are not rated. Ratings are objective, based entirely on a mathematical evaluation of past performance. They're a useful tool for identifying subaccounts worthy of further research, but shouldn't be considered buy or sell recommendations.
Morningstar Risk
An assessment of the variations in a subaccount's monthly returns, with an emphasis on downside variations, in comparison to similar subaccounts. In each Morningstar Category, the 10% of subaccounts with the lowest measured risk are described as Low Risk, the next 22.5% Below Average, the middle 35% Average, the next 22.5% Above Average, and the top 10% High. Morningstar Risk is measured for up to three time periods (three-, five-, and 10-years). These separate measures are then weighted and averaged to produce an overall measure for the subaccount. Subaccounts with less than three years of performance history are not rated.
Morningstar Return
An assessment of a subaccount's excess return over a risk-free rate (the return of the 90-day Treasury bill), after adjusting for all applicable fees, in comparison to similar subaccounts. In each Morningstar Category, the top 10% of funds earn a High Morningstar Return, the next 22.5% Above Average, the middle 35% Average, the next 22.5% Below Average, and the bottom 10% Low. Morningstar Return is measured for up to three time periods (three-, five-, and 10-years). These separate measures are then weighted and averaged to produce an overall measure for the subaccount. Subaccounts with less than three years of performance history are not rated.
Morningstar Category
In an effort to distinguish subaccounts by what they own, as well as by their investment objectives and styles, Morningstar developed the Morningstar Categories. While a prospectus objective identifies a subaccount's investment goals based on the wording in the prospectus, the Morningstar Category identifies subaccounts based on their actual investment styles, as measured by the underlying fund's portfolio holdings (portfolio statistics and compositions over the past three years). If the subaccount is new, and we don't have its portfolio yet, we estimate where it will fall before assigning it a more permanent category. When necessary, we may change a category assignment based on current information.
Volatility Measurements
Standard Deviation
Standard deviation is a statistical measure of the range of a subaccount's performance. When a subaccount has a high standard deviation, its range of performance has been very wide, indicating that there is a greater potential for volatility. The standard deviation figure provided here is an annualized statistic based on 36 monthly returns. By definition, approximately 68% of the time, the total returns of any given subaccount are expected to differ from its mean total return by no more than plus or minus the standard deviation figure. Ninety-five percent of the time, a subaccount's total returns should be within a range of plus or minus two times the standard deviation from its mean. These ranges assume that a subaccount's returns fall in a typical bell-shaped distribution.
In any case, the greater the standard deviation, the greater the subaccount's volatility. For example, an investor can compare two subaccounts with the same average monthly return of 5%, but with different standard deviations. The first subaccount has a standard deviation of 2.0, which means that its range of returns for the past 36 months has typically remained between 1% and 9%. On the other hand, assume that the second subaccount has a standard deviation of 4.0 for the same period. This higher deviation indicates that this subaccount has experienced returns fluctuating between minus 3% and 13%. With the second subaccount, an investor might expect greater volatility.
Mean
The mean represents the annualized average monthly return from which the standard deviation is calculated. The mean will not be exactly the same as the annualized trailing, three-year return figure for the same year. (Technically, the mean is an annualized arithmetic average while the total return figure is an annualized geometric average.)
Sharpe Ratio
Our Sharpe ratio is based on a risk-adjusted measure developed by Nobel Laureate William Sharpe. It is calculated using standard deviation and excess return to determine reward per unit of risk. First, the average monthly return of the 90-day Treasury bill (over a 36-month period) is subtracted from the subaccount's average monthly return. The difference in total return represents the subaccount's excess return beyond that of the 90-day Treasury bill, a risk-free investment. An arithmetic annualized excess return is then calculated by multiplying this monthly return by 12. To show a relationship between excess return and risk, this number is then divided by the standard deviation of the subaccount's annualized excess returns. The higher the Sharpe ratio, the better the subaccount's historical risk-adjusted performance.
MPT Statistics
R-Squared vs. Standard Index
R-squared ranges from 0 to 100 and reflects the percentage of a subaccount's movements that are explained by movements in its benchmark index. An R-squared of 100 means that all movements of a subaccount are completely explained by movements in the index. Thus, index subaccounts that invest only in S&P 500 stocks will have an R-squared very close to 100. Conversely, a low R-squared indicates that very few of the subaccount's movements are explained by movements in its benchmark index. An R-squared measure of 35, for example, means that only 35% of the subaccount's movements can be explained by movements in its benchmark index. Therefore, R-squared can be used to ascertain the significance of a particular beta or alpha. Generally, a higher R-squared will indicate a more useful beta figure. If the R-squared is lower, then the beta is less relevant to the subaccount's performance.
Alpha vs. the Standard Index
Morningstar performs its calculations using the S&P 500 as the benchmark index for equity subaccounts and the Barclays Aggregate as the benchmark index for bond subaccounts. Morningstar deducts the current return of the 90-day T-bill from the total return of both the subaccount and the benchmark index. The difference is called the subaccount's excess return. The exact mathematical definition of alpha that Morningstar uses is listed below.
Alpha = Excess Return - ((Beta x (Benchmark - Treasury))
Where:
Benchmark = Total Return of Benchmark Index
Treasury = Return on Three-month Treasury Bill
Beta vs. Standard Index
Beta, a component of Modern Portfolio Theory statistics, is a measure of a subaccount's sensitivity to market movements. It measures the relationship between a subaccount's excess return over T-bills and the excess return of the benchmark index. Equity subaccounts are compared with the S&P 500 index; bond subaccounts are compared with the Barclays Aggregate Bond index. Morningstar calculates beta using the same regression equation as the one used for alpha, which regresses excess return for the subaccount against excess return for the index. This approach differs slightly from other methodologies that rely on a regression of raw returns.
By definition, the beta of the benchmark (in this case, an index) is 1.00. Accordingly, a subaccount with a 1.10 beta has performed 10% better than its benchmark index--after deducting the T-bill rate--than the index in up markets and 10% worse in down markets, assuming all other factors remain constant. Conversely, a beta of 0.85 indicates that the subaccount has performed 15% worse than the index in up markets and 15% better in down markets. A low beta does not imply that the subaccount has a low level of volatility, though; rather, a low beta means only that the subaccounts market-related risk is low. A specialty subaccount that invests primarily in gold, for example, will often have a low beta (and a low R-squared), relative to the S&P 500 index, as its performance is tied more closely to the price of gold and gold-mining stocks than to the overall stock market. Thus, though the specialty subaccount might fluctuate wildly because of rapid changes in gold prices, its beta relative to the S&P may remain low.