Hmm, I find this hard to square with Table 2 in the paper. That table illustrates consistent growth in the number of misclassified funds. If, as Morningstar alleges, the difference is in controlling for unrated bonds, that still doesn't close the door to deliberate manipulation on the fund side and misreporting on Morningstar's part. For example they say:

>Because Morningstar’s proprietary methodology for calculating Average Credit Quality particularly penalizes unrated holdings by assigning them a low rating (B or BB)

But if I'm the manager of an investment grade fund, why wouldn't I sneak in some crap quality, high yield, unrated bonds? Morningstar will still rate them within the investment grade universe when they might actually be much lower quality. Then all the same problems that the paper alleges arise, my 'unrated' but basically high yield bonds give me good yield and performance numbers and I get a good Morningstar rating and people flock to buy it and I get a nice tidy bonus at the end of the year.

That's quite a response! It sounds as if the authors of the paper would have done well to verify some of their factual assumptions with Morningstar prior to publication.

Some key points from the response:

On the apparent discrepancy between Morningstar's data and self-reported data:

> Because Morningstar’s proprietary methodology for calculating Average Credit Quality particularly penalizes unrated holdings by assigning them a low rating (B or BB), it is not surprising that the authors would find Morningstar’s calculated data to produce a lower average credit quality than self-reported data. When we control for not-rated holdings, we do not find a similar pattern.

How category classification is assigned:

> Throughout the paper, the authors conflate where a fund lands in the Fixed-Income Style Box with its Morningstar Category. In reality, Morningstar’s Fixed-Income Style Box assignment and Morningstar Categories are distinct. Morningstar does not use a fund’s Morningstar Fixed-Income Style Box assignment to determine its category classification.

How star rating is assigned:

> A fund’s star rating is calculated based on past performance relative to peers in its Morningstar Category – rather than relative to funds that share its Fixed-Income Style Box placement, as described above.