Morningstar Inc. on Thursday said it is overhauling the way it classifies and identifies a fast-growing — and for some angst-inducing — group of funds in a category known as “smart beta.”
The research firm, whose star-rating system can make or break funds much like Broadway shows once depended on favorable newspaper reviews, made the announcement at its annual conference on exchange-traded funds in Chicago.
Morningstar's top ETF researcher, Ben Johnson, said the firm is developing an medal-rating system for exchange-traded funds much like the forward-looking endorsement it uses for mutual funds. At the moment, ETFs can receive a star rating from the firm, but not the medal, which is also known as an analyst rating.
“Smart” beta products invest money differently than traditional passive funds. Instead of directing money to stocks based on their size in the market, known as cap weighting, “smart” beta indexers can choose a variety of different ways to weight stocks, for instance, preferring those with less volatility.
Advocates of the products say they can produce larger long-term returns or lower risk, depending on the strategy.
But a number of industry luminaries have been critical of everything from the industry's use of the term “smart,” which Nobel laureate William F. Sharpe says is misleading, to the lofty return expectations promoted on a raft of unproven products.
“Part of our objective in defining the landscape was to wrest the conversation from the possession, chiefly, of marketing departments, product manufacturers, product sponsors, to own it on behalf of investors,” Mr. Johnson, Morningstar's director of manager research for passive strategies, said at the conference. “It marks the first step in what will be an ongoing journey to unpack this space and put it into context.”
As part of
the classification system, which the research firm is promoting as an industry first, advisers and investors can identify, screen and search for funds based on their specific investment style and strategic objective, such as whether they are more risk-oriented or return-oriented.
Among the insights of the analysis is that strategic beta funds, as Morningstar calls them, tend to charge “expense ratios that are more competitive than their comparable actively managed peers,” though in some cases the difference in fees is marginal, Morningstar said in a statement.
Strategic-beta ETFs have drawn $44 billion in flows over the year ended Aug. 31. That's one of every five dollars U.S. investors put into ETFs over that time period.
The classification system and data will be available to users of Morningstar's Direct, Office and Advisor Workstation products.
“There is an investor education issue with respect to strategic beta because everybody has a different definition,” said Joel M. Dickson, a senior investment strategist at the Vanguard Group Inc., who has long been critical of how “smart” beta funds are marketed.
He said the research, which he hadn't reviewed, could help investors “better assess the tradeoffs in these types of strategies.”
