Morningstar Hits Big Board With Style

July 04, 2004

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.

The launch is remarkable in that it marks the transition from Morningstar rating funds, to Morningstar now actually having funds that track indexes of their own.  It will be interesting to see if Morningstar is able to leverage its intermediary relationships, together with BGI and the NYSE's marketing muscle to bring significant assets to these ETFs.  Morningstar has some serious catching up to do, as there are already at least two other ETFs, and in some cases 3 or 4, in every asset class that the Morningstar indexes cover, although the argument could made that the core funds in small- mid- and large-cap make up a new asset class altogether. 

The launch is also significant as a landmark for the NYSE, which is with every passing quarter becoming a more serious player in the ETF market.  Now with numerous primary listings, including two based on it's own indexes, as well as scores of unlisted trading privileges ETFs that trade on the Big Board, the NYSE has made it clear that it intends to say in the ETF business.  The Morningstar listings give the NYSE a broader range of primary offerings now, with complete offerings now covering asset classes across the U.S. market. 

In 2002 Morningstar, long known for independent investment research, released a family of indexes based on its popular style-box categories.  By coming to the market relatively late, Morningstar was able to design an index family that incorporates the current best practices in index construction. 

Morningstar's indexes are free-float, rather than market-capitalization, weighted - which means that a company's weight in an index is based on shares only available for purchase on the open market, and excludes shares held by company insiders and governments, for example. 

Morningstar's index family consists of 16 U.S. equity indexes that track the U.S. market by capitalization and investment style using a comprehensive and non-overlapping approach based on the methodology for the Morningstar style box. The investment style of each individual security is determined by a comprehensive 10-factor methodology that separately measures both the value and growth characteristics of each security, using historical and forward-looking elements.

One of the defining characteristics of the indexes is the treatment of the 'core' style for the stocks for which neither growth nor value characteristics dominate. Such stocks merit their own category, allowing them to be treated as a distinct group. Further, it permits value and growth indexes that reflect the accepted definitions of these different approaches to security evaluation and selection. The 16 indexes in Morningstar Index family serve as building blocks of a diversified portfolio-thus offering a flexible basis for portfolio construction.

It was a long road to market, but Morningstar, iShares and the NYSE finally got a chance to celebrate their new collaboratiion with a bell-ringing on the floor of the NYSE. 


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