Andrew Herdman

Morningstar's ETF Ratings -- What's the Use?

Absolutely right of course. The average investor has no time for serious analysis of risk-adjusted returns and proper selection of appropriate factor-weighted benchmarks. So instead we're showered with simplistic ratings of little or no predictive value. Meanwhile, clever fund managers and ETF sponsors show increasing ingenuity in gaming the rather arbitrary fund categorisation and benchmark selection process, whilst disguising their underlying risk factor tilts. Still, it will be interesting to see whether Morningstar tries to keep the funds and ETFs ratings segregated. Otherwise it really could end up looking like the SPIVA results, with lower cost index funds and ETF's dominating the long term performance charts. By the way, does anyone know what licensing fees Morningstar obtains, if any, for the use of its star ratings, as well as for its indexing methodologies?

Two Concerns With the New ETFs Hitting the Market

I agree with your comments on DFA and characterisation of fundamental indexing as quasi-active 3-factor tilts disguised as passive indexing, flattered by misleading benchmark comparisons.

As for DFA's reluctance to offer ETF's, Vanguard were similarly reluctant to embrace the ETF model but now offer VIPERS. Interestingly I saw an article recently penned by a couple of DFA directors complaining that index mutual funds are disadvantaged in capital gains tax terms compared to ETF's and seeking equivalent tax treatment. As you note, DFA's business model for retail investors is built around selected IFA's charging an additional management fee, partly on the basis of gaining exclusive access to DFA funds. Offering ETF's would make DFA funds available to all, so would require some changes to their distribution model. But I would not be surprised if DFA were to also join the ETF bandwagon.

Meanwhile, keep an eye out for iPath Exchange Traded Notes from BGI, perhaps the start of another wave.
Andy Herdman