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Morningstar Votes for Mutual Funds

Updated from 7:02 a.m. EST

Morningstar, the research firm best known for its ratings and analysis of mutual funds, is drawing criticism for what some people perceive as a negative bias toward exchange-traded funds, one of the country's fastest-growing investment vehicles.

Morningstar denies it has a negative ETF bias, but there is anecdotal evidence to support the claim, which is gaining greater currency among industry observers.

"Morningstar rates mutual funds and that's how they make money," says Barry Mishra, chairman of Accounting and Information Management at University of California-Riverside. If people start investing in ETFs at the expense of mutual funds, he believes the business of ranking mutual funds could lose money.

Morningstar doesn't receive money to rate mutual funds, but fund companies license the use of its ratings for shareholder communications, according to a company spokeswoman. The company's licensed data business comprised 14% of Morningstar's (MORN - Get Report) 2005 revenue of $227.1 million. Licensing of the "star" ratings is a subset of that revenue, and the company does not provide a breakdown of contributions of ETFs vs. funds. Morningstar also has licensed its indices to certain ETF providers.

Still, Mishra and others believe Morningstar has a motivation to discourage the use of ETFs, which resemble index mutual funds but trade on an exchange like stocks.

There are currently more than 8,000 mutual funds on the market with combined assets of about $9.7 trillion. This is a behemoth business compared with ETFs, which have about 300 products trading in the U.S. and about $360 billion in assets. But ETFs are expected to grow rapidly and may begin taking share from mutual funds, which would pose a threat to companies whose success is tightly tied to mutual funds, be it rating or issuing them.

( Full disclosure: TheStreet.com, Inc., publisher of this Web site, also owns TheStreet.com Ratings, Inc. -- formerly Weiss Ratings, Inc. -- which publishes ratings on stocks, mutual funds, ETFs and financial institutions, including life, health and annuity insurers, property and casualty insurers, HMOs, banks and savings and loans.)

Therein lies the bedrock for the theory that Morningstar has a bias against ETFs. But at this point it is just a theory. And Morningstar maintains that's not the case.
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