Lipper vs. Morningstar: Key Differences in Fund Ratings Explained

Investors rely on fund rating systems to evaluate mutual funds and ETFs, with Lipper and Morningstar being two of the most well-known providers. While both offer insights into fund performance and risk, their differing methodologies influence investment decisions. Understanding these differences is essential for effectively using ratings.

Lipper and Morningstar take distinct approaches to fund assessment, shaping how investors interpret ratings and compare funds.

Rating Categories and Scales

Lipper and Morningstar classify funds using different rating systems, each emphasizing specific performance aspects. Lipper assigns ratings in five categories: Total Return, Consistent Return, Preservation, Tax Efficiency, and Expense. Ratings, scored on a scale of 1 to 5, compare a fund’s historical performance to its peers, with 5 indicating the highest ranking. This system allows investors to evaluate funds based on attributes such as capital preservation or after-tax returns.

Morningstar uses a star-based system, rating funds from 1 to 5 stars based on risk-adjusted returns. Funds are grouped by investment style, and ratings are assigned by comparing past performance within each category. The top 10% receive 5 stars, the next 22.5% receive 4 stars, and the middle 35% receive 3 stars, with lower-performing funds receiving 2 or 1 star. This percentile-based approach ensures ratings reflect relative rather than absolute performance.

Performance Metrics

Lipper and Morningstar evaluate performance differently, affecting how investors interpret results. Lipper focuses on absolute and relative returns over time, emphasizing consistency across three-, five-, and ten-year periods. This helps investors assess how a fund performs through market cycles, filtering out short-term fluctuations.

Morningstar prioritizes risk-adjusted returns using its Morningstar Risk-Adjusted Return (MRAR) calculation. This metric accounts for both total return and the level of risk taken to achieve it, penalizing funds with high volatility. By weighing losses more heavily than gains, Morningstar rewards funds with steady returns and lower drawdowns, making its ratings particularly relevant for conservative investors.

Lipper assumes all dividends are reinvested when calculating total return, ensuring income-generating funds are fairly represented. Morningstar follows a similar reinvestment assumption but also adjusts for sales charges and redemption fees, making its ratings more reflective of an investor’s actual experience, particularly for load funds.

Data Sources

The accuracy of fund ratings depends on the quality of data used. Lipper and Morningstar rely on different sources, leading to variations in fund assessments.

Lipper gathers data from fund prospectuses, audited financial statements, and regulatory filings such as the SEC’s Form N-PORT, which mutual funds and ETFs submit monthly. This allows analysis of portfolio composition, asset allocation shifts, and sector weightings. It also incorporates corporate actions like mergers and liquidations, which impact long-term performance.

Morningstar collects data from fund companies, regulatory disclosures, and its proprietary database, covering mutual funds, ETFs, separately managed accounts, and variable annuities. A key distinction is Morningstar’s reliance on portfolio holdings reported by asset managers, often with a 30- to 90-day lag. This delay can affect how quickly changes in a fund’s strategy are reflected. To compensate, Morningstar uses predictive modeling to estimate a fund’s current positioning based on historical patterns and manager behavior.

Risk Assessment

Lipper and Morningstar take different approaches to measuring risk. Lipper focuses on historical volatility and capital preservation, evaluating how consistently a fund avoids significant losses relative to its peers. The Lipper Preservation score measures downside protection by analyzing the frequency and magnitude of negative returns, useful for investors prioritizing loss minimization.

Morningstar incorporates a broader risk-adjusted framework, using metrics such as the Morningstar Risk Rating and the Sortino Ratio, which emphasizes downside risk over overall volatility. Morningstar also categorizes funds into risk bands, allowing comparisons among funds with similar volatility profiles. This prevents naturally higher-volatility funds, such as small-cap growth funds, from being unfairly penalized when compared to lower-risk categories like municipal bond funds.

Frequency of Updates

Lipper updates its ratings monthly, incorporating the latest performance data and risk metrics. Its emphasis on long-term consistency means ratings typically change only with significant performance shifts.

Morningstar also recalculates its star ratings monthly, but its analyst-driven qualitative ratings, known as the Morningstar Medalist Ratings, are updated on a rolling basis. These ratings—Gold, Silver, Bronze, Neutral, or Negative—factor in analyst research and fund manager evaluations. Because they are not purely data-driven, they may be adjusted less frequently than the star ratings unless there are material changes in a fund’s strategy or management.

Relevance for Different Fund Types

Lipper’s rating system is particularly useful for evaluating funds with specific investment objectives, such as tax efficiency or capital preservation. This makes it a strong tool for assessing bond funds, municipal funds, and income-focused strategies, where after-tax returns and stability are key considerations. Lipper’s emphasis on relative performance within peer groups also ensures sector-specific and niche funds are evaluated within their investment strategies rather than broader market trends.

Morningstar’s framework, with its focus on risk-adjusted returns, is often more relevant for equity funds and actively managed portfolios. The star rating system is widely used for comparing large-cap, mid-cap, and small-cap funds, as well as international and sector-specific funds. Additionally, Morningstar’s qualitative Medalist Ratings provide deeper insights into actively managed funds by incorporating analyst opinions on management quality, investment process, and expenses. This makes Morningstar’s ratings particularly valuable for investors who prioritize manager-driven strategies.

Interpretation Considerations

While both Lipper and Morningstar provide useful tools for fund evaluation, investors must understand their limitations. Ratings are inherently backward-looking, reflecting past performance rather than predicting future results. This is especially relevant for funds undergoing management changes or strategy shifts that may not yet be reflected in historical data.

Since both systems compare funds within specific peer groups, a high rating does not necessarily indicate superior absolute performance—it simply means the fund has outperformed similar funds in its category. This distinction is important when comparing funds across different asset classes or investment styles, as a five-star equity fund and a five-star bond fund may have vastly different risk-return profiles.