Are Morningstar Mutual Fund Analysts Taking Happy Pills? Ratings Breakdown.

UPDATE: 8/1/12 - You can see updated ratings as of 6/30/12 here.

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So Morningstar has released new "Analyst Ratings" on 349 US based mutual funds as of 11/15/11. According to Morningstar

"The new scale runs from Gold, Silver, and Bronze on the positive end to Neutral and Negative. Expressed as medals, the top three tiers are reserved for funds our analyst team thinks have sustainable advantages that position them well versus peers and a relevant benchmark on a risk-adjusted basis over the long haul (at least the next five years)"

Morningstar considers Gold, Silver and Bronze to be positive analyst ratings. And obviously the other two are self explanatory. The exact definitions of each are below

Gold: Best-of-breed fund that distinguishes itself across the five pillars and has garnered the analysts’ highest level of conviction;  

Silver: Fund with notable advantages across several, but perhaps not all, of the five pillars—strengths that give the analysts a high level of conviction;

Bronze: Fund with advantages that outweigh any disadvantages across the five pillars, and sufficient level of analyst conviction to warrant a positive rating; 

Neutral: Fund that isn’t likely to deliver standout returns, but also isn’t likely to significantly underperform; and 

Negative: Fund that has at least one flaw likely to significantly hamper future performance, and is considered an inferior offering to its peers.

However, one has to question the way these ratings have been given out for this first batch of 349 funds. 

These must be the parents of Generation Z giving out these ratings because apparently they think you deserve a metal just for showing up. Of the first 349 funds rated, a full 311 or 89% received a "positive" rating deserving of a "metal". Another 30 they are indifferent about and they only have a negative view on 8 or about 2%. 

However, many studies have shown that the majority of actively managed mutual funds actually underperform their benchmarks. Below is a chart from Mclean Heuristics using data from Standard and Poor's Indices verses Active Funds Scorecard.

Clearly that is a sad showing for active managers as a whole. But lets get one thing clear.....I am NOT a supporter of index investing. In fact, I believe index investing (particularly using cap-weighted indexes) only adds to market inefficiency (but that's a rant for another day). 

However, what that chart does show is that if Morningstar was properly distributing it's ratings, it would likely be an inverted version of what they put out. With the majority falling in the "negative" category and the least falling in the "gold" category.

We'll see how the distribution of ratings turns out as Morningstar rolls out more over the next year, but so far it looks to be just as ridiculous as stock ratings given out by the industry. Analysts as a whole in the financial industry are not in short supply of happy pills. After all, Happy Sells!

Updated: 11/17/11 10:20pm ET