What Does Morningstar Have Against ETFs?

Includes: EWY, IXC, PGJ, VDE, XLU
by: Roger Nusbaum

Roger Nusbaum submits: A former colleague of mine sent me the link to this Morningstar article by Dan Colluton. The basic premise expressed is that ETFs may not be all they are cracked up to be because the managers aren't on record for owning shares of their own funds.

Mr. Colluton believes that this can be useful indicator for how much the managers "really believe in the funds they run."

He goes one to say this does matter because, "the interests of managers who are compensated based on how well they run their funds, and who have significant sums of their own money invested in their portfolios, are more aligned with their shareholders."


This seems so upside down I don't know where to begin or end. So is he saying iShares MSCI South Korea Index Fund ETF (NYSEARCA:EWY) is the correct investment for anyone involved in managing it? It seems like an awful lot of all ETFs specialize in a sector or a single country.

If you look at the Morningstar ETF Report page, you will see the most recent report was on the iShares S&P Global Energy Sector ETF (NYSEARCA:IXC). It turns out they think most investors should avoid the fund.

Right before the report on IXC they did one on the Vanguard Energy ETF (NYSEARCA:VDE). What do you know? The risks out weigh the rewards.

The report right before VDE was on the Utilities SPDR ETF (NYSEARCA:XLU). Surely not three for three! Hmm... lessee. It says, "We'd steer clear of this ETF."

I scrolled down to find a country fund and the most recent report I found (I may have missed one on the list) was from December on PowerShares Halter China ETF (NASDAQ:PGJ), and you won't believe this, "We're wary of being tied to single-country funds due to their volatility, which is of even greater concern in emerging markets. Most would be better off with a diversified emerging-markets fund."

I think I am seeing a pattern here. So Morningstar thinks the funds should be avoided, but Morningstar thinks the employees should buy the fund?

The ETF companies picked on the most in the article are iShares and StateStreet. I use more ETFs from iShares than I do from StateStreet, but both are index fund providers. The work involved is making sure the math is right (hyperbole). This is not to minimize the importance of the funds or the people that work there, but running an index is not about adding value, as implied in the article—it is about mimicking. You mimic with computers, not an investment committee sitting around a big old money table debating sector and style rotation. Furthermore, I might suppose that the actual work of implementing and maintaining the fund is done by younger computer-science grads.

The people we see interviewed from these companies are usually from marketing, and so not really stock market people in the way that someone running an open end fund is a market person. For now, any actively managed ETFs are not really that active, they are stock screens. Here again someone clicks somewhere to rerun the screen, then it boils down the software working properly.

I can't believe this was published, but that's just me.