Mutual fund research company Morningstar has begun rating hedge funds.

The company has launched a Morningstar Rating for hedge funds as well as the Morningstar 1000 Hedge Fund Index (MHFI 1000) and 17 indexes based on the Morningstar Hedge Fund Categories. Similar to the Morningstar Rating for mutual funds, the new rating system for hedge funds uses a scale of one to five stars.

Morningstar first categorizes the hedge funds into one of 17 categories, such as "convertible arbitrage" or "emerging market equity," according to a series of quantitative and qualitative measures. Next, Morningstar ranks and rates the hedge funds against their peers in the Morningstar Categories based on risk-adjusted return.

Morningstar's database contains approximately 7,700 direct hedge funds and funds of hedge funds. To qualify for a rating, direct hedge funds must have at least 38 months of consecutive performance data. Funds of hedge funds, of which there are 3,300 in Morningstar's database, are not eligible to receive ratings. Morningstar expects that approximately 1,800 of the 4,400 direct hedge funds in its database will receive ratings.

The Morningstar 1000 Hedge Fund Index, a global benchmark for hedge fund performance, is composed of the top 90 percent of eligible assets in Morningstar's hedge fund database. The index is updated daily for the previous month-end, rebalanced monthly and reconstituted semi-annually. In addition, Morningstar has launched 17 category indexes based on its strategy-specific classification system for hedge funds.

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