Advisors Are Misguided Fixating on the Cheapest or Top-Performing ETFs

CFRA is bolstering its ETF research and changing its rating system. It’s up to investors to use it.

(Illustration by RIA Intel)

(Illustration by RIA Intel)

One of the largest independent investment research firms is shaking up how it analyzes exchange-traded funds. It hopes investors haven’t gotten lackadaisical and that more of them leverage the benefits of the changes.

CFRA, a research firm with more than 75 analysts covering stocks, mutual funds, and ETFs, revealed Monday that in addition to its in-house fundamental and forensic evaluation of ETFs, it will also begin using machine learning “with the goal of identifying the funds with highest probability of outperformance of its equity or fixed income asset type,” it said in a statement.

Todd Rosenbluth, the head of ETF and Mutual Fund Research at CFRA, told RIA Intel the previous model was too “static.” Computers can track fund performance and trends better than an army of analysts and might better predict performance of ETFs through up and down markets. The computer model also scales well over the 1,800 different ETFs that CFRA covers.

How much weight the computer model will ultimately have on the research firm’s ETF ratings is unknown, although it is meant to augment, not supplant, its analysts. “In a simpler manner, the weights to the model will adjust as the model gets smarter over time,” Rosenbluth said.

The New York-based research firm, with over 2,000 clients, including many of the largest wealth managers, is also changing its ETF rating system to one akin to Morningstar’s, from a three-star to a five-star scale.

“Rating stocks and mutual funds on a scale of one to five stars is something our clients have gotten very used to, so it only made sense to take this opportunity to bring that same five-tiered approach to ETFs,” Rosenbluth said.

He hopes investors will consider the ratings from other companies side by side with CFRA’s, too. Every research firm has its own ratings definitions and methodology behind them and Rosenbluth argues there is value in looking at a lot of research collectively.

If there are discrepancies between how research firms rate a security, he hopes advisors will ask more questions about it.

Still, advisors are faced with an increasing number of investment choices and could feel inclined to settle on one research source to drive investment decisions. That could be a mistake.

“We find it is easy for investors to pick one methodology or metric but they will often miss the forest through the trees,” Rosenbluth said. “You can choose the cheapest or best performing ETF, or you can do a little bit of homework with a third party to hear what someone recommends before you make a decision.”

The data powering CFRA’s methodology to rate ETFs is based on proprietary information from First Bridge Data, which the researcher acquired in August of 2019. “We’re now, in January 2020, able to fully leverage those capabilities that CFRA offers including our own proprietary data,” Rosenbluth said.

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