Abstract: Due to demand and growth in the fund industry, simple fund rating tools as a measure of fund performance are becoming more and more important to assist investors in making capital allocation decisions. Thus, it is essential to develop an appropriate approach to rank funds. Previously, Yang and Qiu developed the expected utility-entropy (EU-E) decision model, which brings together the notion of expected utility and entropy together and can effectively consider the decision maker's subjective preferences and objective uncertainty at each state of nature. In the paper, we investigated an alternative fund rating approach based on EU-E model to mitigate drawbacks of the Morningstar ratings, and the ability of fund ratings based on EU-E model and Morningstar to predict fund performance. The Sharpe index, Jensen α, Fama-French three factors and Carhart four factors α have been used as the performance indices using the panel data regression with fixed effect model and random effect model respectively according to the results of F test and Hausman test. The sample period is selected over February 2011 to June 2016, and 261 of funds in the sample are included. The results show that the fund ratings based on EU-E model when λ takes value of 0.25 and 0.75 have excellent forecasting ability while Morningstar ratings have weak forecasting ability. In particular, the 5-star fund performance based on EU-E model when λ takes 0.25 and 0.75 is better than that of the Morningstar ratings; and the EU-E model can better distinguish the performance of different star funds. Furthermore, the conclusions are also robust to one-, three-, and five-year sub-samples. The established approach can provide an additional way to evaluate fund performance and further assist retail investors to better investment decision making.

Key words: fund rating, open-end funds, EU-E model, Morningstar ratings, predictive ability