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ETFs

ETF Ratings Upgrades and Downgrades

There have been few changes since we first began issuing Morningstar Analyst Ratings for ETFs one year ago, but we've ramped up coverage dramatically.

A year has passed since we first incorporated exchange-traded funds into our Analyst Rating framework. Our goal in doing so was to level the field to help investors pick the best funds from an ever-expanding list of choices, said director of global ETF research Ben Johnson.

Because the Analyst Rating we assign to ETFs follows the same five-pillar methodology as the Analyst Rating we assign to mutual funds, it not only helps investors evaluate ETFs, it also is easier to compare ETFs and mutual funds that offer similar exposure. That practice has grown more commonplace in recent years as ETFs have become more widely available and the popularity of low-cost, passive investing has taken hold, Johnson said.

For background, the Morningstar Analyst Rating--which follows a Gold, Silver, Bronze, Neutral, and Negative scale--is forward-looking. It expresses our analysts' conviction in a fund's ability to beat its peers after accounting for fees and risk over a market cycle.

In the 12 months since we initially started rating ETFs, we have

, but we haven't made too many changes to that initial batch of ETF ratings. This is likely reflective of what the team chose to cover during the initial rollout. In deciding which funds to cover, the passive investment analysts took into consideration funds' investment merit and investor interest. As a result, the first wave of rated ETFs represented some of the largest, most broadly diversified, and lowest-cost funds, many of which are backed by top-rated stewards of fund shareholders' capital. Many of those funds retain their high ratings today.

There have been a handful of ratings changes in the past year: six upgrades and three downgrades in total. We take a closer look.

Upgrades

This ETF tracks the Barclays Global Aggregate ex-USD Float Adjusted RIC Capped Index (USD Hedged), a market-cap-weighted index that accurately reflects the composition of the market, mitigates transaction costs, and has a conservative credit risk profile that should offer good downside protection. It is one of the cheapest international-bond funds available. It hedges its currency risk and is conservative with its credit risk, which should also protect on the downside. However, that also limits the fund's return potential. As a result of its low fees (12 basis points) and conservative risk profile, the fund should generate above-average risk-adjusted performance over the long term. It warrants an upgrade to a Morningstar Analyst Rating of Silver from Bronze.

Phillip Yoo

This MSCI ACWI Ex USA Investable Market Index tracker is a solid fund for broad exposure to stocks listed in foreign developed and emerging markets. Its well-diversified, market-cap-weighted portfolio and rock-bottom annual fee (11 basis points) set it apart from its foreign large-blend Morningstar Category peers, and support a Morningstar Analyst Rating upgrade to Gold from Silver.

Daniel Sotiroff

This ETF tracks the Dow Jones U.S. Total Stock Market Mid-Cap Index, which ranks U.S. stocks by market cap, excludes the largest 600 stocks, and targets the next largest 500. It is a market-cap-weighted fund that accurately reflects the U.S. mid-cap stock market. Its efficient index construction, well-diversified portfolio, and low fee (5 basis points) should continue to provide an edge over its peers, supporting a Morningstar Analyst Rating of Gold.

Adam McCullough, CFA

Similar to its mid-cap peer, this ETF tracks Dow Jones U.S. Small-Cap Total Stock Market Index, which ranks U.S. stocks by market capitalization, excludes the largest 750 stocks, and targets the next largest 1,750. The market-cap-weighted portfolio accurately reflects the U.S. small-cap stock market. Its efficient index construction, well-diversified portfolio, and low fee (5 basis points) should continue to propel it ahead of peers, supporting a Morningstar Analyst Rating of Gold.

Adam McCullough, CFA

This FTSE All-World ex-US index-tracker is an excellent choice for exposure to stocks listed outside of the United States. It captures a majority of the foreign investable universe and is well diversified across developed and emerging markets. An updated evaluation of its regional composition and cost advantage has improved our confidence in its ability to perform. These considerations support a Morningstar Analyst Rating upgrade to Gold from Silver.

Daniel Sotiroff

This fund tracks the FTSE Global All-Cap ex-U.S. Index, which covers more than 40 countries across developed and emerging markets. It is an excellent choice for exposure to stocks listed outside of the U.S.; it accurately represents the foreign investable universe and is well diversified across developed and emerging markets. After further considering its regional composition and cost advantage, we have increased confidence in its ability to perform. We upgraded its Morningstar Analyst Rating to Gold from Silver.

Daniel Sotiroff

Downgrades

This is one of the cheapest and best-diversified funds in the Europe-stock Morningstar Category. It tracks the broadly diversified, market-cap-weighted MSCI Europe Investable Market Index, which promotes low turnover and accurately represents the composition of its target market. Its low fees (10 basis points) and representative market-cap-weighted portfolio should give it an edge over the long term. But the fund has a limited performance history and has not yet distinguished itself, warranting a Morningstar Analyst Rating downgrade to Silver from Gold.

Daniel Sotiroff

This ETF is one of the cheapest funds of its kind--Vanguard recently cut the fund's expense ratio to 10 basis points from 12. It's also one of the best diversified Europe-stock funds available; it tracks the FTSE Developed Europe All Cap Index, which is a broad market-cap-weighted index of stocks from 15 developed European countries. However, the fund's performance does not stand out from its category peers; therefore, we downgraded its Morningstar Analyst Rating to Silver from Gold.

Daniel Sotiroff

This is by far the largest real estate exchange-traded fund, with more than $30 billion in assets, and it's also one of the cheapest, with an expense ratio of 0.12%. It features experienced management and an excellent record of tracking its index, MSCI US REIT Index, which includes all domestic REITs from the MSCI US Investable Market 2500 Index. It remains a fine option in its niche, but we downgraded its Morningstar Analyst Rating to Silver from Gold, to better align its rating with those of similar funds and to reflect the risks of single-sector funds.

David Kathman

The full list of rated U.S.-listed ETFs is

.

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