Research company subjects index vehicles to its one-to-five-star ratings. Morningstar has begun applying its star rating system to U.S.-based exchange-traded funds (ETFs). The Chicago-based investment-research company says the idea is to “help investors and advisors compare the risk-adjusted returns of ETFs with other ETFs and similar open-end mutual funds,” according to a Morningstar press release.

“Increasingly, investors are using [ETFs] as vehicles to help them implement their investment strategies,” says Dan Culloton, Morningstar’s senior mutual-fund analyst. ‘By providing ratings on ETFs, we can help investors do their homework and better evaluate whether an ETF makes sense for their portfolios.”

ETF assets have grown rapidly in recent years. In January 2006 the combined assets of all U.S. ETFs came to about $313 billion, according to the Investment Company Institute, up from $223 billion in January 2005 – and up from $72 billion in January 2001.

Morningstar compares each ETF with open-end mutual funds in the same Morningstar peer group. To be eligible for a rating, the ETF must have three years of returns. Because investors have to pay commissions to purchase and sell ETFs on an exchange, Morningstar models the trading commissions for an ETF by using a nominal front load and deferred load for each rating period.

As with Morningstar’s mutual-fund rating system, ETFs are rated with one to five stars, depending on how they've performed compared with funds that share the same investment style and focus and after adjusting for risk and accounting for all sales charges.

Morningstar subscribers can login to see the ratings and analysis of the ETFs here. The company offers a two-week free trial. Morningstar has been rating mutual funds since 1985. –FWR

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