ETF industry sees birth of more rating services

Mar 12, 2007 @ 12:01 am

By David Hoffman

PHILADELPHIA — The number of companies that rate exchange traded funds — and the methods they use to rate them — is growing.

XTF LP of New York became the latest company to provide ETF ratings last month. The partnership, which builds and markets ETF portfolios through its subsidiaries XTF Advisors LLC and XTF Capital LLC, also of New York, launched a free web-based ratings service. ETFs are rated based on 16 metrics over two broad categories: investment metrics and structural integrity.

The launch follows that of AltaVista Independent Research Inc. of New York, which began offering fundamentally driven research on ETFs online for a fee in October.

In using AltaVista’s website, investors can examine the aggregate earnings growth, price-earnings ratio or dividend yield of an ETF.

Morningstar Inc. of Chicago, however, got the ETF ratings ball rolling a year ago when it began rating ETFs based largely on their risk-adjusted performance — the same way it rates mutual funds.

The reason for the interest in rating ETFs is obvious, said industry experts: ETF growth has been phenomenal.

In January, ETF assets rose by $8.45 billion, or 2%, to $431 billion, according to the latest available data from the Investment Company Institute in Washington. Over the 12-month period ended Jan. 31, ETF assets increased $111.36 billion, or 34.8%.

Some financial advisers said they welcome ETF ratings.

“The more rating agencies there are, the more tools you have,” said Benjamin Tobias, president of Tobias Financial Advisors Inc. of Plantation, Fla.

But not all the tools are created equal.

For example, Mr. Tobias is most concerned about how closely an ETF tracks its index. For that, he turns to Morningstar’s ETF analysis.

Other advisers, however, said that although Morningstar’s overall analysis may be good, the ratings it slaps on ETFs is flawed.

It’s based too much on past performance, said Herb Morgan, president of Efficient Market Advisors LLC of San Diego.

It’s a common complaint advisers have about Morningstar’s ratings — regardless if they apply to ETFs or mutual funds.

But the complaint is unfair because the ratings are supposed to be used as a starting point for investors considering an ETF or mutual fund, said Sonya Morris, editor of Morningstar ETFInvestor, a newsletter published by Morningstar.

Mr. Morgan, however, was not impressed. He was impressed, however, by the ratings now being offering by XTF.

The company offers three ratings: an overall rating, a rating based on a fund’s structural integrity and a rating based on investment metrics. It’s the structural integrity measure, however, that Mr. Morgan has found most useful.

The measure includes metrics such as tracking error, expense ratio, bid-ask ratio, market impact, concentration risk, efficiency and capital gains distributions.

“That’s pretty valuable information,” Mr. Morgan said.

Valuable online ETF information also can be found using AltaVista, said Michael Krause, president and founder of the company.

AltaVista is the only research tool that provides ratings based on the fundamentals of the companies in the ETFs themselves, he said. But it rates only 35 ETFs, although those ETFs account for about 70% of ETF assets, Mr. Krause said. And unlike Morningstar and XTF, it charges for its research.

A basic subscription to AltaVista’s service costs $29 a month, or $299 per year.

“It is a lot of work,” Mr. Krause said. “I think that’s why no one else bothers to do it.” Not everyone, however, thinks it’s worth it.

“I would say I have yet to see a rating system … that has benefited investors,” said Jim Lowell, the Needham, Mass.-based editor of the Forbes ETF Advisor, a monthly newsletter. However, he offers an ETF ranking service.

Scores given to each ETF in each category are a summation of an ETF’s record and mainly take into account each ETF’s risk-adjusted relative return.

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