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ETF Hurdle Rate

An ETF's hurdle rate is the sum of its portfolio's weighted-average cost of equity (COE), its annual expense ratio and, in certain cases, an incremental risk premium. We derive the weighted-average COE using the costs of equity that Morningstar equity analysts assign to the portfolio holdings they cover.

The COE expresses a firm's intrinsic risk as a percentage (e.g., 10%). It represents the minimum return an investor would accept in exchange for purchasing the stock. (For portfolio holdings that our analysts don't cover, we assign a 10.5% COE, a figure that approximates the COE of the average stock in our coverage universe.) A fund's annual expense ratio is the percentage fee that an ETF levies.

For purposes of the hurdle rate calculation, we use each fund's prospectus net expense ratio. Finally, we add an incremental risk premium to account for the higher risk that certain ETFs pose. This figure will vary depending on the risk of the ETF concerned.

 

 

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