This is the article I wanted informed comments on the most
Individual funds are returns maximizing, and if they can convince Morningstar (or their ultimate investors) that they are making more return not for taking more risk, but through skill, they will attract assets and make more money.
Thus it's explicitly in the fund managers interest to try to maximize return, while minimizing perceived risk. One way of doing that is through purchasing securities which are 'stamped' by a third party as less risky then they are (subprime being the classic example here).
Morningstar can try to structure them into reporting their portfolio to avoid this, but that reporting system can always be gamed.
Meaning, ultimately like with all investing, if you just trust the passive allocator/machine to make decisions for you based on overly simple or gamable rules...it will end in tears.
Wouldn't this rise to the level of fraudulent and thus criminal?
The fact that these ratings have been assumed to be a reliable proxy for risk in the market (to the point that people automate based on it) is likely the bigger issue here and the larger cause of the systemic risk of incorrect ratings.
Sure, some funds have a "go anywhere" IPS, but ratings downgrades often causes a flurry of asset sales.
If you say your holdings are 90% IG, and then after a downgrade they are only 70% IG, then you have two options: #1 - sell the downgraded assets to bring it back into compliance, or; #2, if you are within your funds stated IPS, then you have to restate the number as 70%, and have to remove all literature that references the 90% number.
IG = Investment Grade IPS = Investment Policy Statement
And that explains why this article is on the front page of HN...not because the methods are accurate, but because the conclusion aligns with what people believe going in.
Fund managers very likely are slimy, but this paper is too flawed to prove anything. Read the rebuttal from Morningstar. In the paper Morningstar's data is being assumed true while the bond funds are being criticized, so when Morningstar comes out and says that their data has a pessimistic bias, and the bonds funds ratings reflect more complete information, it seems pretty damning for the paper's assumptions.
Maybe you are trying to say something else?