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Morningstar launches Star Ratings for hedge funds

Date: Friday, February 29, 2008
Author: PR Newswire

Morningstar, Inc. MORN, a leading provider of independent investment research, today launched the Morningstar Rating for hedge funds as well as the Morningstar(R) 1000 Hedge Fund Index (MHFI 1000) and 17 indexes based on the Morningstar Hedge Fund Categories.

Similar to the Morningstar Rating for mutual funds, the new rating system for hedge funds uses a scale of one-to-five stars so that similar numbers of hedge funds receive one and five stars. Rather than use the self-described categories provided by hedge fund managers, Morningstar first categorizes the hedge funds into one of 17 Morningstar Categories, such as "convertible arbitrage" or "emerging market equity," according to a series of quantitative and qualitative measures. Next, Morningstar ranks and rates the hedge funds against their peers in the Morningstar Categories based on risk-adjusted return.

The risk-adjusted return calculation and rating address two issues that are specific to hedge funds. First, unlike many other risk-adjusted performance measures such as the Sharpe ratio, the Morningstar hedge fund rating does not assume that funds have returns that follow the normal bell curve distribution. Second, the rating addresses the fact that some hedge funds invest in illiquid securities that are infrequently priced.

Infrequent pricing gives hedge fund managers "flexibility" in how they value such positions when calculating returns that they report to hedge fund databases. The result is a "smoother" or less volatile reported return series. To correct for this, Morningstar applies a statistical procedure to the return series and then calculates the risk-adjusted return measure. This risk-adjusted return measure accounts for all variations in a fund's monthly performance, with more emphasis on downward variations.

Morningstar's database has approximately 7,700 direct hedge funds and funds of hedge funds. To qualify for a rating, direct hedge funds must have at least 38 months of consecutive performance data. Funds of hedge funds, of which there are 3,300 in Morningstar's database, are not eligible to receive ratings. Morningstar expects that approximately 1,800 of the 4,400 direct hedge funds in its database will receive ratings.

Morningstar also launched the Morningstar 1000 Hedge Fund Index, a global, broadly representative benchmark for hedge fund performance. The index is composed of the top 90% of eligible assets in Morningstar's hedge fund database. For the purposes of the index, Morningstar counts funds with shared portfolios as a single hedge fund; funds of hedge funds are excluded from consideration. The index is updated daily for the previous month-end, rebalanced monthly, and reconstituted semi-annually. In addition, Morningstar has launched 17 category indexes based on Morningstar's strategy-specific classification system for hedge funds.

"We believe the Morningstar Rating for hedge funds is the best starting point for judging a fund's past performance. We want to make researching hedge funds a more transparent process, and our new ratings and indexes will allow qualified investors, advisors, and institutions to better evaluate and compare hedge funds to their peers," said John Rekenthaler, vice president of research.

As previously announced, SGAM Alternative Investments (SGAM AI), a wholly owned subsidiary of Societe Generale Asset Management, has selected Morningstar to provide its institutional clients with hedge fund data, portfolio evaluation, analysis tools, indexes, research, and ratings. Through its New York-based affiliate, SG Asset Management, Inc., SGAM AI will provide customized hedge fund portfolio advisory services to institutional investors.

Hedge fund star ratings and indexes are now available to Morningstar Licensed Data clients...Full press release: