Much of the hype around a mutual fund is placed on the person managing it. In the world of finance, fund managers have garnered celebrity like qualities, with much of this having to do with the star rating systems, popularized by investment research agencies like Morningstar. Within this star rating world, 4 and 5 star rated managers represent to many the crème de la crème of mutual funds. For some, having a 5 star coveted manager is a bragging right. For others, it is a sense of security that their investments are in the right hands.
But the question is, how predictive is this star-rating system? Do highly-rated fund managers really offer the consistent returns and security people crave? The answers to these questions are at best, mixed. For example, some newer fund managers who are highly rated, have only been managing for 3-5 years. If they took control of a fund during a bull market, the rating system over this one period may not fully depict how skillful they actually are. A more appropriate 10+ year ranking would certainly provide more clarity.
It is important to realize however, that neither a fund’s past performance nor its star ranking can predict the future outcome. There are currently many 4-5 star rated funds that a decade ago lost 80% of their value in one year, then another 50% a year later. It is also important to consider that the performance of a fund is also based on the amount of risk it takes on. While one tends to focus on the benefits of a fund, one also needs to be prepared for potential huge losses during a bear market.