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February 09, 2011 |
When Do ETFs Make The Grade? |
A new rating system to help financial advisors understand and compare exchange-traded funds was unveiled this week at the 4th Annual Inside ETFs Conference.
Held at the Westin Diplomat Resort in Hollywood, Fla., the conference was attended by about 1,000 people and approximately 60 exhibitors. The show has grown steadily over the years and is viewed as the go-to place for financial advisors to learn about ETFs. Sessions this year covered more than 20 topics, including some on choosing ETFs, comparing ETFs and mutual funds, selecting region-specific and commodity plays, and undertstanding ETF risks.
Many at the show were interested in the new A to F ratings system introduced by the conference founders and organizers, IndexUniverse, which provides news, data and research on ETFs and indexes.
More recently the company started ETF Analytics, which developed the ETF ratings system. Matt Hougan, president of ETF Analytics, and Dave Nadig, IndexUnverse's director of research, introduced the product to the crowd.
Entering beta testing now, ETF Analytics' research and rating system will likely be available for financial advisors to buy in the spring or summer, said Elisabeth Kashner, CFA, the company's senior vice president of analytics who oversees eight other analysts. The company has not yet finalized pricing for the new system, she said.
ETF Analytics first is focusing on rating sector ETFs and eventually plans to grade all exchange-traded products, which now include about 1,100 ETFs and exchange-traded notes. The company is referring to both as ETFs, as is commonly done by investors, the company said.
ETF Analytics' classification and ranking system is not primarily aimed at evaluating fund performance. Instead, it focuses more on what's under the hood of an ETF so advisors can be sure they're getting the exposure they want in a particular sector.
"Our product is strictly focused on beta exposure ... It's to give our users a tool to get the market exposure they intend to get, and also to understand the cost of getting that exposure," Kashner said.
She noted there are very specific risks and rewards associated with ETFs that may or may not exist in the rest of the market. For example, ETFs have a different creation/redemption process and different challenges with keeping their price in line with their net asset value than mutual funds. They also can be traded during the day like stocks but unlike mutual funds.
ETF Analytics' new system grades ETFs based on three overall metrics: efficiency, tradability and fit.
Efficiency assesses how well an ETF tracks its own index. To judge efficiency, Kashner's team looks at tracking error, expense ratios, fund structure, risk of fund closure, transparency, tax risks, performance and standard error of beta.
Tradability measures the likelihood an investor will get a fair deal when buying or selling an ETF. The company evaluates this based on a proprietary measure of underlying liquidity.
A fund's fit score assesses how well the ETF tracks a benchmark for its group that is chosen by ETF Analytics. For most of the sector ETFs, the company is using Thomson Reuters indexes as benchmarks.
Efficiency, tradability and fit are given numerical grades of between zero and 100 that are weighted to come up with the ETF's letter grade. Kashner said ETF ratings will be updated quarterly, but if events warrant they'll be updated sooner.
In its research prototype provided to conference attendees, ETF Analytics evaluated eight financial ETFs. The prototype includes a six-page overview on the sector and then two-page reports on each ETF that break down how the group arrived at the rating.
For example, Dow Jones U.S. Financial (IYF) received an overall grade of A-: 91% for efficiency, 97% for tradability and 81% for fit. "Overall the fund captures the financial sector space well and compliments that exposure with excellent tracking of its index and deep liquidity, making it the highest scoring fund in its segment,” the report says.
Another example, PowerShares Dynamic Financial Portfolio, receive a grade of C-: 77% for efficiency, 76% for tradability and 57% for fit. The fund suffered on efficiency because of its high expense ratio and difficulty tracking its own index. With only $19 million in assets in the fund, ETF Analytics felt there was risk that PowerShares might close the fund. Tradability also wasn't great because of low investor interest and premiums and discounts that regularly widen to half a percent. Its fit score was low because the portfolio is tilted more toward small-caps and insurance than the ETF Analytics' benchmark.
"For our beta test we are definitely targeting financial advisors. We see tremendous potential for this product to be useful to traders, to be useful to institutional investors, and I have a personal desire to also see it expanded to the individual market,” Kashner said.
IndexUniverse publishes Journal of Indexes and Exchange-Traded Funds Report in conjunction with Charter Financial Publishing Network (CFPN), the parent company of Financial Advisor magazine. CFPN, Credit Suisse and Bendigo Partners recently led a round of equity financing for IndexUniverse to launch ETF Analytics.
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When Do ETFs Make The Grade? |
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