Morningstar’s Australian ETF ratings leave trail of confusion

Morningstar’s fund rating system has always been influential and controversial.

Influential because fund buyers often rely on Morningstar, meaning the company’s ratings have outsized say over who gets money.

Controversial in that their ratings have always created a steady stream of enemies. Underperforming managers never liked getting caught in the poke. But even sympathetic observers can find them grating from time to time.

This has been particularly true in recent years, as Morningstar has expanded the scope of its ratings system and widened out its asset management services.

A good example of the grating is Morningstar’s ratings of Aussie core ETFs.

Ticker Fund name Morningstar analyst rating
A200 BetaShares Australia 200 ETF Bronze
IOZ iShares Core S&P/ASX 200 ETF Bronze
STW SPDR S&P/ASX 200 Bronze
VAS Vanguard Australian Shares Index ETF Bronze

Core Aussie equity ETFs are some of the most popular and successful funds in Australia, containing roughly $10 billion in investor money between them.

They’ve opened up Aussie asset management, allowing poorer and younger investors access to world class investments. They’ve also helped mainstream and overdue discussion on management fees.

But going through Morningstar’s ratings system you wouldn’t get that impression.

Every Aussie core ETF has been slapped with a bronze rating, giving them ratings below many active managers. The ratings come despite a similar performance over the past ten years to gold-rated managers, and comparable or better performance the past five years.

Vanguard Australian Shares Index ETF Pendal Australian Share Fund Schroder Australian Equity Fund Fidelity Australian Equities Fund Schroder Equity Opportunities Fund
Returns  –  5 year 8.42% 8.50% 7.14% 8.60% 7.40%
Returns  –  10 year 9.28% 9.24% 9.76% 10.71% 10.25%
Morningstar Rating Bronze Gold Gold Gold Gold

Source: Morningstar Direct

In justifying the bronze medals, Morningstar said:

“Our preferred active managers have been able to outperform Australian equity benchmarks over the long run, even after accounting for their higher cost, and there is reason to believe the best active managers can continue to deliver.”

The review puts Morningstar’s Aussie and US ratings in bit of a contradiction. In the US, core ETFs – such as the iShares S&P 500 ETFs (IVV) – get gold ratings from Morningstar.

The ratings difference occurs despite core ETFs performing similarly in both countries compared with active money managers, data from S&P Global indicates.

Percentage of large cap funds that outperformed benchmark

United States (S&P 500) Australia (ASX 200)
Five years 17.9% 20.4%

Source: S&P Global

Making matters more confusing is Morningstar’s recent decision to award gold ratings to Vanguard’s multi-asset ETFs. The multi-asset ETFs simply invest in other Vanguard index funds. What makes the decision strange is that they invest in other Vanguard funds with bronze and silver ratings.

Index funds underlying Vanguard’s gold-rated multi-asset ETFs

Morningstar Rating
Vanguard Australia Shares (VAS) Bronze
Vanguard Australia Fixed Interest (VAF) Silver
Vanguard Global Shares (VGS) Silver
Vanguard International Small Companies No rating
Vanguard Emerging Markets Bronze
Vanguard Global Aggregate Bond Bronze

The whole is often greater than the sum of its parts. But how a bag of bronze and silver funds, add up to a gold is not immediately clear.

Contacted for comment by ETF Stream, Morningstar analyst Tim Wong gave two arguments for the bronze ratings. First: “Morningstar assesses performance on both an absolute and risk adjusted basis. The figures you have included only relate to absolute returns.”

Second: “The large cap US market is considered to be the most efficiently priced…meanwhile, while we understand that the past 18 months have been difficult for active Australian equity managers to outperform the index, they have historically fared better compared to active US equity strategies.”

On the surface at least, these two arguments circle back to the active versus passive debate. Active managers cannot, in aggregate, provide better risk-adjusted returns than the index. The same is true everywhere and for the same reason.

They also appear at odds with Morningstar Direct data on Sharpe ratios (below) and the S&P Global data above.

Vanguard Australian Shares Index ETF Pendal Australian Share Fund Schroder Australian Equity Fund Fidelity Australian Equities Fund Schroder Equity Opportunities Fund
3 year Sharpe ratio 1.11 1.13 1.28 0.84 1.05
5 year Sharpe ratio 0.61 0.64 0.4 0.63 0.5

Source: Morningstar Direct

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