CFRA has revised its methodology for rating the performance of particular ETFs, intending to help investors and advisors better discern which ETFs are most likely to remain strong in volatile markets, the research organization announced today.
The new methodology includes previously employed approaches, including CFRA’s forensic earnings quality scores, which can show which ETFs will outperform similar types. However, too many investors choose ETFs based on what has worked in the past, assuming that prior performance can persist indefinitely, according to Todd Rosenbluth, the head of ETFs and mutual fund research at CFRA.
However, in an interview with WealthManagement.com, Rosenbluth said this mindset wasn’t grounded in reality; since ETFs tend to be index based, they are more closely tied to the performance of the securities within the portfolio in contrast to actively managed funds.
“At the fund level, our focus on performance is shifting toward looking at historical performance in up and down markets as opposed to seeing performance in a more general term,” Rosenbluth said. “By specifically targeting funds with limited downside that still participate in the upside and rewarding them, we’re increasing the likelihood of finding future consistent winners.”
He pointed out that many ETFs had actually launched in the midst of the past decade’s bull market, and many funds that have outperformed have done so in part by taking on additional risk. Through CFRA’s methodology, he hopes investors and advisors alike can find the funds likely to perform well without excess risk.
“We haven’t seen a prolonged level of volatility in equity or fixed income markets in the life of most of these ETFs,” he said. “What has worked in the past is unlikely to work in the future.”
In addition to the changes to its methodology, CFRA is also changing how ETFs are rated, moving from a three-tiered rating system to a five-tiered star system. The five-star system will work similarly to how the organization rates stocks and mutual funds. According to Rosenbluth, a five-star ETF will be expected to outperform similar ETFs in the next nine months, while a one-star-rated ETF will likely underperform under the same criteria. Rosenbluth said the synchronicity between stocks, mutual funds and ETFs would help clients.
“The ETFs were the anomaly of that trio for the past 10 years,” he said. “We’re putting the three types of asset classes in sync with one another so our clients understand that our top picks are five stars and bottom picks are one star.”
Last August, CFRA acquired First Bridge Data and has been working to incorporate that company’s data to augment its own ETF ratings and classifications. Rosenbluth said First Bridge’s data was particularly powerful because its classification systems were unique to what investors and advisors might consider when judging different ETFs. According to Rosenbluth, CFRA had been in the process of upgrading its ETF methodology for several years (both Rosenbluth and First Bridge founder Aniket Ullal are contributors to WealthManagement.com).
“The inclusion of the First Bridge data was a logical next step, to have in-house data that was world class and could support the framework we were looking for with clients,” he said.
