Many mutual fund companies that for years have been blissfully churning out sales materials mottled with
highly regarded star ratings and data are in for a rude awakening. Now Morningstar says it's time to pay the piper.
Over the past 18 months Morningstar has started enforcing a long-ignored policy of charging a licensing fee for the use of its ratings and data in mass communications. The fee doesn't cover magazine and newspaper ads, but does include just about every other star-spangled medium, including Web sites, postcards and fact sheets. Although the firm isn't actively hunting delinquent fund companies, it has found between 10 and 20 so far.
Investors needn't worry that the popular star ratings will disappear from mutual fund literature. Fund companies are more likely to grit their teeth and cut a check than tell Morningstar to take a hike. Boston-based fund tracker
Financial Research Corp.
estimates that up to 75% of fund sales go to funds with four- and five-star ratings from Morningstar.
"Let's face it, American consumers love ratings. It doesn't matter whether you're talking about movies, cars, ice cream or funds," says Joel Davis, a senior financial planner with
American Express Financial Advisors
in Portland, Maine.
Although the fee policy has been in place for years, many fund companies ignored it because the fee was originally charged on an impractical per-use basis, says Morningstar product manager Marla Sewall.
"We wrote very specific licenses for each use, but that approach was too time consuming," says Sewall. That prompted Morningstar to devise its current unlimited use license, which charges a fund family a flat annual fee based on the fund company's number of funds. While fees can range widely, all are less than $100,000 annually.
As you might imagine, fund companies don't like paying for a service they once thought was free. "Morningstar has become a necessary evil," gripes one fund executive currently negotiating a licensing agreement with Morningstar. "They've got us over a barrel."
But fund companies don't want to publicly criticize the vaunted Chicago fund tracker. None of the 10 fund firms consulted on this topic agreed to speak on the record. Many, including $574.5 billion
, refused to discuss the fee at all.
"There's what I can say with my name attached to it, and there's the reality of the situation, which I don't want attached to my name. Which do you want?" asked one marketer at a large fund firm that has not signed a licensing agreement.
Why so mum? Fund companies say they can't afford to alienate Morningstar. Even a marketing chief at a fund company that doesn't use Morningstar ratings or pay a fee concurs. "The stars are just a harsh reality. They've got most fund companies where they want them. It puts us at a disadvantage not to pay and use them."
Ironically -- cynics might say conveniently -- fund firms say that although Morningstar's sterling reputation among investors makes it hard for them to snub the fee, the fee itself could create a conflict of interest.
Over the past few years Morningstar has expanded the menu of products and services it offers to fund companies. Some allege that as Morningstar turns more of the fund companies it rates into clients, its objectivity could be compromised.
"I think it does create a conflict of interest. But what can you do? The fund companies and consumers are held hostage," says AmEx planner Davis.
Morningstar's Sewall disagrees. "It's definitely an issue we've heard. But there's a Chinese wall between the editorial and data analysts and the business group."
The financial services industry is rife with similar conflicts, says private money manager Bruce White of
in Pasadena, Calif. As examples, he cites brokers being paid more to sell some products over others, analysts rating potential investment banking clients, and funds agreeing to place trades with brokerage firms in exchange for the firms' research.
Still, a fund marketer at one of the 10 largest firms considers Morningstar to be a special case: "All of Morningstar's success is based on their perceived objectivity and credibility. I think they have to be very careful here."
It's important to note that rival fund picker
Standard & Poor's
also charges fees to fund firms to reprint reports and use its "Select List" icon in materials.
doesn't levy a fee to advertise its data, but did not respond to questions regarding the costs of its database.
More than one fund executive says the fees are just a way to beef up Morningstar's books with recurring revenue -- rumors of an IPO swirl around the firm from time to time. But Morningstar spokeswoman Martha Conlon, citing a $91 million investment last September by Japan's
, denies any plans to go public. Besides, notes another observer, the fees are relatively modest.
Sewall says Morningstar hasn't made a point of finding firms that have been skipping the fee. The company pursues the issue when it comes across unlicensed fund companies using data or ratings on Web sites or in mailings.
"We find them all the time," says Sewall. "There's still many companies that do it today."
Fund companies beware.