Morningstar and Barclays Global Investors Link Up for New ETFs

March 14, 2004

Now a way to invest directly in style boxes.
Barclays Global Investors said it has inked a deal with Morningstar to license the Chicago stock and fund tracker's 16 style-based indexes. Last week BGI filed a prospectus for nine iShares Morningstar exchange-traded funds (ETFs) with the SEC.

With expense ratios ranging from 0.20%-0.30%, the funds listed in the filing are designed to track the following Morningstar style-based indexes:

· Morningstar Large Value Index
· Morningstar Large Growth Index
· Morningstar Large Core Index
· Morningstar Mid Value Index
· Morningstar Mid Growth Index
· Morningstar Mid Core Index
· Morningstar Small Value Index
· Morningstar Small Growth Index
· Morningstar Small Core Index

The Morningstar U.S. Market Index covers approximately 97% of the U.S. stock market.

Index
YTD return (%)
1-Year return (%)
3-Year return (%)
US Market Index
0.30
43.29
-1.16
Large Cap Index
-0.42
38.13
-3.51
Mid Cap Index
2.00
54.07
4.36
Small Cap Index
2.74
67.80
8.34
US Value Index
1.56
47.27
3.78
US Core Index
0.95
43.34
-0.27
US Growth Index
-1.64
39.66
-8.18
Large Value Index
1.01
42.84
1.52
Mid Value Index
3.08
55.08
8.68
Small Value Index
2.68
71.31
15.78
Large Core Index
0.29
38.34
-3.58
Mid Core Index
2.51
56.01
9.40
Small Core Index
3.27
62.36
11.41
Large Growth Index
-2.59
33.84
-9.70
Mid Growth Index
0.38
50.56
-5.51
Small Growth Index
2.24
71.15
-1.53

Source: Morningstar Indexes, data as of March 11, 2004


Reaching out to advisors and individual investors

With its highly recognizable brand name, databases, and vaunted style boxes, Morningstar seems like a natural index provider.

"Many advisors follow Morningstar's research and determine a target asset allocation for their clients based on the Morningstar Style Box," said Lee Kranefuss, CEO of BGI's intermediary business.

"Our style box methodology is a very popular way of looking at the stock universe with financial advisors and individual investors - now they will have actual investments based on the style boxes," said Joe Mansueto, founder, chairman, and CEO of Morningtar.

So far institutional investors and sophisticated traders have been the primary users of ETFs, but Vanguard, BGI, and others have eyed the financial advisor and retail investor market.

"The opportunity to bring the iShares brand together with the Morningstar brand we think will appeal to our existing clients, as well as to a wider range of investors who may not have looked at us or ETFs before," said J. Parsons, head of sales for BGI's Intermediary Business.

A question of style

In the indexing industry, the trend is toward higher complexity when it comes to structuring style index methodology.

"We believe the Morningstar indexes offer a higher level of style purity, partly because we use a 10-factor style methodology," said Mansueto. The ten factors are:

Value Factors
• Price/projected earnings
• Price/book
• Price/sales
• Price/cash flow
• Dividend yield

Growth Factors
• Long-term projected earnings growth
• Historical earnings growth
• Sales growth
• Cash flow growth
• Book value growth

 

"Unlike some indexes, a stock cannot be in multiple indexes," said Mansueto. "We also have a 'core' category for stocks that are not strong value or growth. In some existing indexes for example, stocks may end up in the growth camp simply because they're not value, or vice versa."

With back histories to 1992, the Morningstar Indexes website has more information on the index methodology, returns, and constituents.

"There are no gaps or overlaps in our indexes, so they work nicely as portfolio building blocks," said Mansueto.

Outsider moves inside

The move to partner with a fund provider could be a bold step, because Morningstar is known for its unique and independent fund commentary and ratings. (Index providers normally receive a licensing fee that is a small percentage - usually a few basis points - of the ETF's assets.) Morningstar has been active recently in partnering with several other financial services firms.

Mansueto said there is a wall between the index business and Morningstar's fund analysts.

"Our index business is separate from the analyst group," said Mansueto. "We don't rate ETFs currently, but it's possible we may do so in the future. However, our ratings are purely quantitative and transparent - there are no subjective elements."

Morningstar experienced at least one false start before lining up BGI as the ETF manager.

 

***

John Spence is an editor at IndexUniverse.com. Check out his musings on the ETF industry each Monday at CBSMarketWatch.com. If you have ETF story ideas, contact him at [email protected]. Also contact him if you have an article submission for The Journal of Indexes -- or if you're a financial reporter wishing to interview Steven Schoenfeld on his upcoming book Active Index Investing.

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