"I would like to stress that the Morningstar Rating for hedge funds is a purely quantitative measure based on returns reported to us by the hedge fund and [is] not subject to third-party verification, like mutual funds," Spelhaug said in an e-mail.
Investment advisers touted the five-star rating by Morningstar - heavily relied on by many individual investors - in their sales pitches for the Life's Good fund, which supposedly had $43.91 million in assets, according to a report download on April 16 from the Morningstar Alternative Investment Center.
The report said the fund made high-yield, short-term loans to contractors who fix up distressed properties.
A chart on its returns from April 2007 to April 2010 showed $10,000 growing in a perfectly regular upward progression to $16,000.
"If I'm a financial adviser and I'm looking at a perfect step-up performance report, I have to know something is wrong," said G. Mark Brewer, a San Diego lawyer with a client who in mid-April invested in Life's Good through Total Wealth Management, a registered investment adviser that is based in San Diego.
Investors said Total Wealth Management referred to the Morningstar rating to assure them that the Life's Good fund was solid. The owner of Total Wealth Management, Jacob Cooper, has not responded to requests for comment. Neither has Stinson.
Spelhaug said Morningstar flags hedge funds for deficiencies in four areas: administration, auditing, registration, and return pattern.
Life's Good was flagged on the first three criteria, indicating that investors needed to exercise extra due diligence, she said.
Contact staff writer Harold Brubaker at 215-854-4651 or firstname.lastname@example.org.