Leading investment researcher and ratings house van Eyk has changed the way it rates exchange-traded funds to reflect the important differences between ETFs and other managed funds.
van Eyk has simplified its ratings scale for ETFs so that funds which participate in a review and make it through its initial screening process can only be rated an A or B.
If it is found that there is a high probability the fund will track its underlying index and has a strong portfolio construction and investment process (including an appropriate fee structure) and is part of a well-run business, it will be awarded an “A”. If it lacks these qualities and there is, therefore, a low probability it will produce returns similar to the index, it will receive a “B” rating.
van Eyk recently released its first ratings under the new system, assessing two “smart beta” ETFs from Russell Investments. Head of Ratings Matt Olsen said the new ratings system recognised that investors had a simple and unambiguous aim when investing in ETFs – to receive a return that closely matched the return of the underlying index.
“ETFs either do the job they were designed to do or they don’t,” he said. If an ETF could not perform that function it should not be used by investors, no matter what other qualities it or the manager might have.
“To be useful to an investor, the rating on an ETF needs to give them confidence that the ETF will achieve its objectives and deliver the desired exposure,” Mr Olsen said.
van Eyk’s rating for a fund which is not sufficiently competitive in its peer group to warrant a review (“Screened”) and the “Refused Review” rating for a fund which declines to participate in a review will continue to apply. Unlike other research houses, van Eyk does not accept payments from fund managers for a rating.
As well as interrogating an ETF manager’s investment process and business management, van Eyk also considers past performance and transaction costs (the bid-ask spread) when evaluating the probability of an ETF tracking the underlying index. The strength of the business managing the ETF is particularly important because ETFs often require a large amount of initial investment in product infrastructure and development to be successfully managed, Mr Olsen said.
In addition to their primary rating, van Eyk also awards ETFs “risk ratings” on their investment strategy and on the underlying index they track. A structurally complex investment strategy might receive a “high” risk rating, as might an ETF which tracked an index that lacked liquidity or was more volatile than other indices.
16 July 2012
