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.