The debate about the impartiality of fund ratings agencies has reignited as Hawksmoor Investment Management’s Jim Wood-Smith accused the system of being “rotten”.
Fund ratings services have begun to play an increasingly important role in the post-RDR world, since some advisers use them as a key part of their due-diligence process.
Some adviser firms only include funds on their panel of potential investments if they have certain ratings.
But Mr Wood-Smith has attacked ratings agencies, fund providers and the firms that rely on such ratings as part of a “broken process”.
The ratings companies rely, in part, on payments from fund providers, which pay to advertise the ratings on marketing materials.
Mr Wood-Smith, who as a discretionary manager offers advisers outsourced asset management services without the need for fund ratings agencies, questioned what value there was to be gained from such “allegedly impartial assessments” when a fund provider had paid a fee to the researcher.
He said: “Everyone is guilty to a certain degree in a rotten system. Providers who have paid for ratings are also culpable, as are those who use them as threshold qualifications knowing that they are compromised.”
Fund ratings services have rallied to the defence of their business models in response to the accusations, insisting on their impartiality and a separation between the commercial and fund research parts of their business.
One issue for such fund ratings systems is that without payment from fund providers they are unlikely to be able to continue their work. This is because users, such as advisers, will be loathe to pay for research that until now has been free.
Mr Wood-Smith said: “The only way I can see round it is for the FCA to ban providers from paying for research, and that isn’t going to happen.”
Geoff Mills, director of Rayner Spencer Mills Research (RSMR), said the “pay to play” model of fund groups paying to get their funds rated had “proved to be broken” but had not died out.
He said RSMR’s process was “completely independent and completely impartial” with the commercial side of the business, where managers pay RSMR to use its ratings on marketing material, “completely separate” from the fund research part of the business.
Peter Toogood, co-founder of fund ratings service The Adviser Centre, said he understood concerns about the fact that ratings firms were being paid for by fund providers.
But he insisted there was no alternative to that business model because users would not want to suddenly pay for a service that had been free for so long.
He said: “The smell [around the sector] cannot go away unless the third parties start paying, but I do not think that will happen.
“The FCA could force it but I do not think [it] will.”
Mika-John Southworth, director at FE Analytics, said there was “no possibility of bias” in its ratings.
A spokesperson for Square Mile said there was “absolutely no financial consideration involved in Square Mile’s process of reviewing and compiling recommended lists”.
Morningstar said its research was “independent”.
“Only our manager research team – which is separated from our commercials team –decides which funds are covered by our analysts for research and ratings,” the agency said.
Transparency is key to distinguishing fund raters from credit agencies
Hawksmoor’s Jim Wood-Smith has compared the practices of the fund ratings industry to the credit ratings agencies that gave suspect loans AAA credit ratings in the build-up to the financial crisis.
But the fund ratings industry has said its transparent methods distinguish it from the controversial practices of organisations such as the credit ratings agencies before the 2008 crisis.
The Adviser Centre’s Peter Toogood said that, in contrast to the aloof, faceless credit ratings firms and their complex rating systems, fund raters such as himself are generally easily contactable by investors seeking an explanation for ratings.
“It is our reputations that are at stake and that does mean something, especially as advisers can directly contact me,” he said.
And the ratings methodology for the main fund ratings firms are also easily accessible on their websites, although the presence of qualitative judgements means investors cannot fully appraise most systems.
