For Mandatory Provident Fund (MPF) investors, the absence of useful, comprehensive tools for trustee selection can make the process seem like a guessing game. Morningstar believes that MPF investors deserve the benefit of clear, reliable information that will assist them in making long-term investment decisions with confidence, and clarity. To remove opacity and enhance transparency in the trustee selection process, Morningstar has created the Quantitative Trustee Report (QTR). The QTR summarizes the average relative performance of each MPF scheme, and serves as an easy reference for trustee selection. While it's not possible for the QTR to capture every aspect of trust evaluation and assessment, we think it serves as a useful first step toward helping investors make sound and informed decisions.   

Average Morningstar Rating and Scheme Quality
The average Morningstar Rating offers investors a quick glimpse into how trustees and their MPF schemes have recently performed. Generally speaking, the longer the average Morningstar Rating bar, the better the offerings’ average quality. However,not all MPFs in the schemes are rated, so the average Morningstar Rating may not fully reflect the average quality of an entire given scheme.

There are two circumstances under which MPFs may not be rated:

 1) They belong to one of the Morningstar categories listed in Exhibit 1, below. These categories aren't rated because peer comparisons would be either meaningless,or inappropriate.

2) The MPFs have track records spanning fewer than three years. As a rule of thumb, the greater number of funds are rated, the more meaningful the average Morningstar Rating.

Exhibit 1: UnratedMorningstar Categories 

When assessing the average Morningstar Rating, it's vital to look at the total number of rated MPFs. If the number of rated MPFs is insignificant to the total number of offerings, its average Morningstar Rating would be less meaningful. That said, it is meaningless to rate guaranteed funds and money market funds. Not rating these kinds of funds does not harm the power of the average Morningstar Rating.

Why Morningstar Rating?
Investors might ask themselves why we use the Morningstar Rating rather than other risk-adjusted return measures. A walk through what the Morningstar Rating makes the answer clearer. The Morningstar Rating is a quantitative assessment of a fund’s past performance – both return and risk – and ranked on a scale of one to five stars. MPFs are ranked by their Morningstar Risk-Adjusted Return (MRAR) scores, and stars are assigned using the following scale:

MPFs are rated from up to three trailing periods – 3, 5, and ten years – and the overall rating is calculated by applying the following weights:

There are two overarching reasons why we endorse the Morningstar Rating as the best indicator of MPF’s relative performance:

First, our rigorous methodology allows only the top 10% of funds in each Morningstar category to earn our best rating. For funds with track records of more than five years, they must remain atop in their categories across time horizons of varying lengths in order to earn our five-star rating. It's even more difficult for a trustee to obtain an impressive average Morningstar Rating, since it has to manage products of various kinds, and still achieve favorable results over an extended period.

Second, the Morningstar Rating employs an enhanced risk measure. The Morningstar Rating is based on “expected utility theory.” As a result, it emphasizes downward variations, and rewards consistent performance. This methodology helps to reduce the possibility of strong short-term performance, which can mask a fund's inherent risk. With this enhanced risk measure, we believe Morningstar Rating is fair measure of an MPF's relative risk-adjusted performance.

Does the Average Morningstar Rating Mean Everything?
It means a lot, but it's not meant to be all-encompassing. In addition to the average Morningstar Rating, there are several important issues investors should carefully consider when interpreting the QTR.

1.    Product Variety  

This is a key factor that deserves investors' attention. The MPF scheme should provide investors the insight they need to achieve optimal asset allocations. It's pointless for an investor to pour his or her pension money into a trustee if it does not offer the asset classes most consistent with his or her investment objectives, regardless of its average Morningstar Rating. The average Morningstar Rating figure is important, but investors should also delve more deeply into the schemes to assess their suitability. Quality and suitability are two key criteria for trustee selection.

The more offerings an MPF scheme offers, the more liberty investors can enjoy. This liberty, although valuable, is not considered in the Morningstar Rating computation process.

2.    Degree of Difficulty 

Is it appropriate to conclude that the trustee with the highest average Morningstar Rating is the best? No! Obviously, it is much easier to obtain a good average Morningstar Rating for an MPF scheme that only offers five products as compared to another one that offers 15 products. If we take this degree of difficulty into consideration, the big picture would look different.

3.    Good at What You Want

An average Morningstar Rating of four doesn't mean that all MPFs in the scheme are rated as four-star. Under normal circumstances, this average Morningstar Rating of four would be made up by some good offerings (rated as four- or five-star) and some not-so-good offerings (rated as three-star or below). Therefore investors should be aware of the strengths and weaknesses of each trustee before making an investment decision. For example, it's pointless to stick with a trustee with good fixed income offerings if the investor’s portfolio has a heavy tilt toward equity funds.

4.    It is NOT a Forward-Looking Measure

Investors should be keenly aware that the Morningstar Rating is computed by assessing historical performance, and that past performance is not a predictor of future results. As such, a high rating alone is an important but not sufficient basis for making investment decisions.

5.    Young Schemes Deserve Consideration Too

Green funds aren't rated until they obtain performance track records of at least three years. In some cases, young MPF schemes would have no average Morningstar Rating at all, but this doesn't mean they're necessarily bad. All good funds, as well as trustees, must start somewhere. Investors can assess the relative performance of offerings (no matter how short the track records are) in the scheme to see whether they are outperformers in general. Besides, light experience in the MPF space shouldn’t be a concern, if the trustees have deep experience in asset management.

6.   Does Not Fully Reflect Subadvisor Changes

Each MPF’s Morningstar Rating is calculated based on the broader track record of the fund itself, and not on the specific performance of its subadvisors. Put more clearly, if an MPF elects to outsource the fund’s management, or to change its subadvisor, the Morningstar Rating will reflect the performance of all of its investment managers and subadvisors, in aggregate, up to the past ten years. Although each investment manager may implement his or her own variations to the fund’s investment approach, style, or discipline, we believe the Morningstar Rating should capture an MPF’s total performance, assimilating the cumulative impact of all of its underlying subadvisors. 

You can click here for the QTR sample and here for all the average Morningstar Rating of the MPF scheme covered by the QTR (Report as of 30/06/2013).