Irwin Schrödinger used his cat to explain a peculiar fact ofquantum physics known as the “superposition of states.” In histhought experiment, using the kind of mathematics you only see innightmares, Schrödinger proved the cat can be both alive and deadat the same time. Weird, right? 

I mention this as a way to introduce the controversy of the“superposition of states” of Morningstar's Star Ratings. Shouldthey be used as a predictive reference, or should they be viewedsolely as a historical evaluation? 

A 1996 academic study showed Morningstar's Star Ratings had nopredictive value, and Morningstar concurred. Advisors pointed tothis study to support their views. But Morningstar has sincechanged its algorithm, hurling the study into irrelevancy.

Morningstar's tune has remained remarkably consistent. In theDec. 6, 1996, issue of Morningstar Mutual Funds, Amy C.Arnott said, “Many commentators insist on treating the star ratingas a predictive measure or a short-term trading signal. The rating,which is clearly labeled as a historical profile, doesneither.”

Subsequent to their algorithm change in 2002, Christine Benz inher 2005 book Morningstar's Guide to Mutual Funds, said,“…the star rating is based on how the fund did in the past. Itwon't predict short-term winners.” 

Finally, Don Phillips, in 2010's “Star Wars, the Sequel,” said“The Morningstar Rating for funds is a grade on past performance.Period. No one at Morningstar ever claimed that the stars havepredictive power.”

But now Morningstar's tune might be evolving. 

A spokesman for Morningstar told me, “…after we changed ourmethodology in 2002,… we did find some moderate predictivevalue.”

Edwin Choi, however, in his article, “Morningstar Ratings:Useful or Useless?” analyzed a 2010 Morningstar study. He concludedthe study showed the expense ratio was a better predictor ofoutcomes than the Morningstar Rating.

Two Pace University professors ran an independent study andreported, “…we find widespread support for the notion that the newMorningstar rating system can predict future performance…”

Yet Morningstar's own licensing agreement, after sketching outhow the Star Rating is calculated, states “Past performance is noguarantee of future results.”

When asked if it believes the stars are predictive, aMorningstar spokesman said: “That depends on your interpretation ofthe word 'predictive' – [does it mean] guaranteed or associatedwith good outcomes?” Morningstar's Star Rating doesn't 'guarantee'any results. We believe the star ratings are associated with goodoutcomes, but we've always said we don't want people buying fundssimply because they have 5 stars.

So do they or don't they? In Morningstar's eyes, the answerappears to be an unequivocal, “Yes.” 

Schrödinger would be proud.