Morningstar set to rate model portfolios

Morningstar Inc. is developing ratings for advisers' exchange-traded-fund model portfolios, a first for the burgeoning industry. The goal of Morningstar's new ratings initiative is to shed light on a space that has grown quickly but also lacks transparency, according to officials for the fund research firm. Over the past couple of years, the number of independent advisers pitching their own ETF model portfolios to investors — and to other advisers — has exploded. This has raised worries among some regulators, who have voiced concerns over the last year that many advisers offering these model portfolios aren't sophisticated enough to do the proper due diligence on the underlying ETFs — and essentially are making performance claims that can't be verified. In the long run, regulators contend, investors could get hurt. In September, the Securities and Exchange Commission said it was examining the use of ETF model portfolios. “It's like the old newsletter scam where someone publishes five newsletters with five different strategies and then after a couple years kills two of those newsletters because the performance was down and just touts the remaining strategy as its top-performing one,” Scott Burns, the ETF research analyst at Morningstar in charge of developing the model portfolio ratings, told InvestmentNews in an interview at IndexUniverse's Inside ETFs Conference. By rating model portfolios, Morningstar hopes to add transparency to this market, Mr. Burns said. “Everything shows that when you shine a light on a market, it grows,” Mr. Burns said. Morningstar is in talks with sponsors of exchange-traded funds to help aggregate the model portfolio information and so far has 312 model portfolios. Morningstar is still in the process of figuring out how it will categorize the model portfolios, but to be eligible for a rating, the model portfolio will have to have 50% in ETF assets and have a three-year track record. Getting the data will be a key challenge, Mr. Burns acknowledged, noting that while this project is his 2011 initiative, he can't provide a precise time for when the ratings will launch. “It's not as simple as going in and scraping prospectuses,” he said.