What are we looking for
Canadian-listed exchange-traded funds that have average performance but are poised to outperform.
The screen
Not long ago, my colleague Michael Dobson, CFA, wrote a brief article highlighting a few balanced funds that, while delivering average historical returns, appear well positioned to outperform going forward. Today, I’m expanding on that concept across the universe of Canadian-listed ETFs – now numbering more than 1,700.
Long-time readers will know that I often reference two of Morningstar’s flagship fund ratings: the Morningstar Star Rating and the Morningstar Medalist Rating. The Star Rating (formally known as the Morningstar Rating for Funds) is widely used in Canada and is commonly displayed on fund profiles. This rating is an objective, backward-looking measure of a fund’s risk-adjusted performance relative to category peers, using a time horizon of at least three years (and up to 10, if available). The methodology places greater weight on more recent performance and applies a utility function that emphasizes downside protection – something particularly relevant to retail investors. Notably, the Star Rating is based entirely on historical data and contains no analyst input.
In contrast, the Morningstar Medalist Rating is a forward-looking, qualitative assessment of a fund’s potential to outperform its category after fees. It’s based on three core pillars: (1) people (evaluates the experience, stability and alignment of the investment team), (2) process (assesses the clarity, repeatability and effectiveness of the fund’s investment approach) and (3) parent (considers the asset manager’s overall stewardship, corporate culture and alignment of incentives with investors). Each pillar is scored independently, and the combined result – together with considerations for fees and risk – determines the fund’s overall rating of gold, silver, bronze, neutral or negative. Funds that receive a medal (gold, silver or bronze) are those that Morningstar believes will outperform category peers in the future.
Importantly, both the Star Rating and the Medalist Rating incorporate fees into their assessments, rewarding funds with lower management expense ratios (MERs).
Today, I use the ratings to identify ETFs that have delivered average historical returns (i.e., a three-star rating) but are currently rated gold, silver or bronze under Morningstar’s forward-looking Medalist framework. In a nutshell, I’m looking for funds that have performed “just fine” so far, but score well based on Morningstar’s qualitative analysis, and have the ingredients to outperform peers going forward.
Only Canadian-listed ETFs that are actively covered by Morningstar analysts were considered in this screen.
What we found
The ETFs that qualified are listed in the table accompanying the article inclusive of tickers, categories, MERs, Morningstar ratings, trailing returns and inception dates. Investors are urged to first consider the asset class and category to which each ETF belongs, given that Morningstar’s ratings are meant to be observed relative to category peers.
This article does not constitute financial advice. Investors are encouraged to conduct their own independent research before buying or selling any of the ETFs listed here.
Ian Tam, CFA, is director of investment research for Morningstar Canada.