IDEAS home Printed from https://ideas.repec.org/a/eee/finlet/v78y2025ics1544612325003381.html
   My bibliography  Save this article

The cost of misclassification in mutual funds

Author

Listed:
  • Fang, Fei
  • Parida, Sitikantha

Abstract

In March 2020, Morningstar revised its Low Carbon Designation (LCD) methodology. Before this revision, U.S. mutual funds were categorized into two groups: those meeting low-carbon thresholds (labeled as LCD funds) and those that did not (non-LCD funds), which were perceived as high-carbon funds. Crucially, many funds lacking available carbon metrics were not categorized separately from non-LCD funds, resulting in their misclassification and the mistaken perception of being high-carbon funds. The updated methodology introduced a third category—missing rating funds—to represent funds for which the LCD could not be determined. Our analysis reveals that the failure to distinguish missing rating funds from non-LCD funds resulted in approximately $21.3 billion in lost flows to these funds compared to LCD funds over the three months preceding the revision. After the change, these previously misclassified funds experienced a significant recovery, attracting approximately $15.6 billion more than non-LCD funds within three months. Our findings highlight the substantial financial consequences of fund misclassification. They also reveal that investors respond strongly to fund ratings, even when inaccurate, suggesting a preference for ratings over underlying information.

Suggested Citation

  • Fang, Fei & Parida, Sitikantha, 2025. "The cost of misclassification in mutual funds," Finance Research Letters, Elsevier, vol. 78(C).
    • Handle: RePEc:eee:finlet:v:78:y:2025:i:c:s1544612325003381
    DOI: 10.1016/j.frl.2025.107074
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S1544612325003381
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.frl.2025.107074?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    More about this item

    Keywords

    Mutual fund flows; Morningstar low carbon designation; Fund misclassification;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:finlet:v:78:y:2025:i:c:s1544612325003381. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no bibliographic references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/frl .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.