...to reduce complexity (Kahneman, 2000). Rating methodologies may contain ambiguities that discount the value of the ratings, and at minimum argue for the use of more than one method to select investments. Regulators would benefit from understanding the problems that have been identified with Morningstar. More importantly, regulators should understand how investors make choices and how Morningstar may influence those choices. The powerful image created by Morningstar star ratings may contribute to a degradation in the quality of investor choice. Morningstar simplifies the investors search for information and reduces complicated quantitative performance data to simple images and symbols. The fund companies use Morningstar's rating system extensively in their advertising and this further reinforces the simplification of a complex choice.

INTRODUCTION

Extensive rules have evolved to protect buyers from the unscrupulous, and product disclosures are a mainstay of those rules. Kirsh (2002) asks a simple question: "does disclosure appear to work?" More specifically, does disclosure help consumers understand enough about the product to make reasonably informed choices? Equity products are inherently more complex and risky than many types of products, and the sources of information investors use to make investment decisions are of critical importance.

Regulations that stipulate what, when and how investment firms can communicate with the public are voluminous, and oversight is shared among several federal agencies, self-regulatory organizations (SRO) and the fifty states. The number and types of investment alternatives have exploded and the number of mutual funds exceeds 12,000. Comparative rating agencies have evolved to simplify the decisions making process for the consumer and these rating services describe themselves as the "trusted source" whose mission is to "help investors make better decisions." Of these agencies Morningstar is the best well known and acts as a pseudo consumer advocate when they tout their "independent expert view." Does Morningstar help consumers understand enough about the product to make reasonably informed choices, or do they oversimplify a complex choice by limiting the information upon which consumers will base their investment choices?

It is important to recognize that the capacity of disclosure to actually achieve transparency, foster product knowledge and facilitate comparison-shopping has typically been assumed as a matter of common sense (Kirsch, 2002). The National Association of Securities Dealers (NASD) the primary SRO dedicated to overseeing mutual fund companies have queried their membership as to whether they should continue to prohibit the use of bond mutual fund risk ratings by their members. They where specifically concerned that "some ratings represent their opinions by a word, symbol or number that attempts to be a single, all encompassing measure of a fund risk." Morningstar star ratings are arguably the most well known third party provider of information on mutual funds used by fund companies, advisors and investors. The star ratings oversimplify a complex and profound choice by capitalizing on an individual's limited ability to process information (Simon, 1957) and a need to reduce complexity (Kahneman, 2000).

The simplicity of the star ratings obviates product disclosures and act as buying heuristic. The stars become the primary proxy for choice, and while Morningstar indicates that the ratings are historical tools and do not predict the future the powerful image they create overshadows their warning. Vinod and Morey (2002) indicate that while the cautionary advice offered by Morningstar is sound, many people still use the ratings as a predictor of future investment performance. Jacoby, Chestnut and Fisher (1978) in a behavioral process approach to information acquisition found that people acquired a mean proportion of 2% of the available information and that information search concentrated on 6 of the 35 available information dimensions. Studies also demonstrate that consumers acquire less information when brand names are present (Jacoby, Chestnut & Fisher 1977; Van Raajj 1977). Morningstar is arguably better known as a brand than many of the fund companies themselves.

Hutchinson and Alba (1991) report that consumer learning of even simple relationships may frequently fail. Consumer learning is of critical importance because consumers must learn what attributes are important and other variables that differentiate products from one another. The more information attributes a product possess the more likely choice complexity and beliefs are formed based on irrelevant information. Hutchinson and Alba (1991) assert that from a public policy perspective consumers are considerably at risk. A distinction must be made between the availability and the processability of information (Kuusela and Spence, 1998). Processability refers to the ease with which information can be assimilated and used, and is therefore affected by how it is presented. The powerful image created by Morningstar ratings may contribute to a degradation of the quality of investor choice.

Morningstar simplifies the investors search for information and reduces complicated quantitative performance data to simple images and symbols. The fund companies use Morningstar's rating system extensively in their advertising and this reinforces the simplification of a complex choice. The star system allows consumer to frame investment questions more readily, weigh their choices systematically and anchor their performance expectations consistently. Although, research demonstrates that the same information presented in different formats can result in different decisions (Bettman, 1986). Complicate arise when fund companies compete for investor funds through advertising that skews the framing of choice, redistributes weights assigned to choice, and...

NOTE: All illustrations and photos have been removed from this article.



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