MORNINGSTAR WANTS TO RATE MUTUAL FUND COMPANIES IS IT 4 OR 5 STARS FOR FIDO? SALES IMPACT MAY BE HUGE

No longer content merely to rate mutual funds, Morningstar Inc. plans to start grading the companies that make and market them.

The Chicago mutual fund researcher is a few weeks into developing qualitative and quantitative criteria for measuring the strength of fund companies, confirms research director John Rekenthaler.

Possible indicators to be looked at include quality of research, experience and depth of management, overall performance of a company’s offerings, as well as hiring and training practices.

The evaluations, to be implemented as soon as this fall, could profoundly influence individual investors and financial advisers. Morningstar’s five-star rating system for fund performance already is a standard guide for fund shoppers. By grading marketers, Morningstar could steer some investors toward companies that are praised and away from ones that are damned – before they consider particular funds.

“Some companies spend a lot of money building deep and talented staff” while others are thin, says Mr. Rekenthaler. “This is important information for you as an investor to know.”

By way of illustration, Mr. Rekenthaler adds, “Peter Lynch’s numbers would not have been as good had he not been at Fidelity and around people who nurtured his thinking.”

Advisers appear to believe such research would prove useful. Jeffrey J. Stenroos, president of Integrated Capital Planning in Akron, Ohio, says corporate ratings are important.

“I think (the research) would be helpful to all the people in the investment community,” says Mr. Stenroos. “Corporate cultures are going to produce different results.”

Dan Orescanin, an individual investor from Scottsdale, Ariz., agrees: “There’s not a lot of information available with the depth you’d like. The better informed the investor, the better decisions he can make.”

Some fund managers say the evaluations could be useful, but add that determining and weighting criteria could prove challenging.

“How do you measure the quality of an organization?” asks Jerry Paul, a senior vice president for Denver-based Invesco Funds Group, who oversees several bond funds. “If there’s some way to pull it all together it’s probably useful to people, but it’s a complicated subject.”

“The concept sounds reasonable,” says Bettina Doulton, a vice president at Fidelity Investments and manager of the Boston company’s Puritan and Equity-Income II funds. “It will be interesting to see what metrics they use.”

Mr. Rekenthaler will be interested as well, given that the project is “six inches off the ground” at this point.

Although the initiative is new, Morningstar has contemplated creating such a rating system for years, Mr. Rekenthaler says, out of the belief that the organizations of fund companies are critical. The notion was rekindled by internal discussions several months ago about the continued strong performance of Janus funds in the wake of hot fund manager Thomas Marsico’s 1997 departure.

Major questions still need to be resolved, including what factors will be looked at and what sort of simple-to-understand ratings – based on stars, numerals or some other dingbat -to publish.

When it comes to evaluating inhouse research, Mr. Rekenthaler says, Morningstar probably will consider whether companies bring anything new to their analysis or if they merely parrot the Wall Street line.

Morningstar also will probably look at a fund group’s overall performance, he adds. While having a weak fund in a weak sector is forgivable, an underperforming fund in a strong sector would raise a red flag.

Also to be decided: how to disclose the judgments. Possibilities range from including the evaluations as separate items in Morningstar fund reports to incorporating them in the star ratings of funds.

Rating the firms would give investors an idea of how the funds might perform in the face of adversity, Mr. Rekenthaler explains. Not all firms have the experience or expertise to make adjustments if stocks go south.

“If T. Rowe Price has a fund that’s kind of ill, the odds are good that T. Rowe Price will focus on that problem,” Mr. Rekenthaler says. “They have the resources to fix a problem. Other companies might have 20 holes in the dike and only a few fingers.”

Mr. Rekenthaler concedes the new system could cause a ruckus – particularly if an organization’s grade is factored into a fund’s star rating.

Morningstar’s star system is one of the strongest buy or sell influences on investors and financial planners. The addition or loss of a star can mean millions to an individual fund.

“If we build it into the star ratings it’ll have a big impact; companies will lobby us,” says Mr. Rekenthaler. “Fund companies feel that five stars sells funds. If people’s five-star funds get that lowered, that hurts the bottom line.”