Morningstar becomes an Aussie ETF provider, raising questions about conflicts of interest

Having long sat on the side-lines critiquing other companies’ ETFs, Morningstar Australia is entering the ETF market itself.

The Morningstar International Shares Active ETF (MSTR), which listed today, will invest in a currency-hedged portfolio of global shares. It will provide an ASX-listed gateway to its actively managed fund of the same name.

The fund buys global companies based on quality and value characteristics, Morningstar indicates in its product disclosure statement. It then provides a passive currency hedge using derivatives.

Beyond this, little else about the investment strategy is given away.

5 Year Total Return Management Fee Total Expense Ratio Morningstar Rating Morningstar International Shares (hedged) 9.04 0.39% 0.49% Unrated Vanguard International Shares Index (hedged) 9.51 0.21% 0.23% Silver

The fund has underperformed Vanguard’s passive international shares index fund the past five years. The ETF share class of Vanguard’s international index fund, VGS, is rated silver by Morningstar.

Morningstar's Australian ETF ratings leave trail of confusion

MSTR's 0.39% fee - which increases to 0.49% once transactional and operating costs are included - is double the fee charged by Vanguard.

Morningstar provides a wide range of ETF-related services in Australia. These include not only its ratings service, which reviews Australian ETFs, but also more crucially a "managed accounts" service.

These managed accounts offer advisors a one bullet solution for building client portfolios. They work in a similar way to robo-advisors in that they build portfolios by buying a salmagundi of ETFs. The ETFs crammed into these managed accounts are chosen and weighted based on clients' risk appetites.

Managed account providers like Morningstar then charge a layer of fees on top of the underlying ETF fees. Morningstar charges roughly 0.65-0.72% for its managed accounts.

While nothing is mentioned in Morningstar's public documents that we can find, it seems highly likely that the company will use MSTR in its managed accounts. Morningstar already makes use of its own funds in its managed accounts.

The listing of MSTR raises questions about Morningstar's business model and how it manages its conflict of interests. These conflicts include not only how its analysts objectively rate competitors' ETFs, but also on what basis ETFs are chosen for its managed accounts.

Morningstar has some policies in place to deal with these conflicts. These policies prevent the company from rating funds where it has a direct commercial interest, either as the index provider or fund manager. While when the company selects its own funds (and now potentially ETFs) for its managed accounts, it uses the zero fee share class. This ensures that there is no double dipping on Morningstar's part.

Morningstar's rating system has received criticism from academics, industry professionals and mainstream newspapers for its inaccuracy.