Investment research firm CFRA today announced it has enhanced its exchange-traded fund ratings methodology by combining its proprietary forensic and fundamental approaches.

Todd Rosenbluth, CFRA’s head of ETF and mutual fund research, said the company's ETF research previously included its analyst-driven STARS (Stock Appreciation Ranking System) coverage of stocks based on earnings forecasts and relative valuation assessments of 1,500-plus global stocks. Its new ETF ratings methodology will also include CFRA’s proprietary forensic accounting-based earnings quality scores for tens of thousands global companies.

“This will provide better risk assessment at the holdings level, seeking to avoid downside performance, as well as help us to broaden our U.S.-listed equity coverage into more international markets," Rosenbluth said in an emailed comment. “The number of ETFs we rate will increase.”

He noted that CFRA’s new analytical model differs in two main ways from its prior model. One, it’s using machine-learning techniques to determine the weightings of the model on a monthly basis rather than keeping the model static as in the past.

“As a result, we expect to learn what is working in the current environment and adjust based on risk-on or risk-off periods,” Rosenbluth explained.

Second, the new model will seek to identify the probability of outperformance of a U.S. diversified equity fund, such as the Vanguard S&P 500 ETF (VOO), compared to its specific universe, and a U.S. sector equity fund, such as the Technology Select Sector SPDR Fund (XLK), versus its germane universe.

“In the past we have grouped ETFs like VOO and XLK together,” he saId. 

Another new wrinkle is the move from a three-tiered weighting system for ETFs to a five-tiered star system. A five-star ETF is expected to have a total return that beats a similar group of ETFs over the next nine months. A one-star ETF means the total return is expected to underperform a similar group of ETFs during that same time frame.

CFRA’s additional capabilities in forensic analysis come courtesy of its acquisition of data-and-analytics firm First Bridge Data last August. Specifically, Rosenbluth said, CFRA is incorporating First Bridge’s proprietary ETF-specific data and classifications into its ratings and research rather than relying on third-party data from a firm that’s focused on mutual funds.

“This will allow us to better compare smart beta and thematic ETFs with one another, allowing clients to separate those from cap-weighted funds, as well as fully incorporate our holdings-based approach,” he said.

CFRA’s new methodology will be featured in its ETF research reports starting this spring.