Fundhouse’s fee model may shake up ratings world

It’s not a new debate. Back in the 1990s Standard & Poor’s was a pioneer in offering a systematised, qualitative ratings process for actively managed funds. Today it’s a vast global player, although last year it scrapped its UK fund research arm.

S&P used to charge fund managers for submitting their funds for review – a model scathingly known as ‘pay to play’.

It often faced accusations – consistently rejected – that this could be an incentive to dish out positive reviews to encourage fund managers to come back for more.

How easy would it be to take a fund manager’s money and then turn around and slap them in the face with a hatchet-job negative review?

In 2002 research firm OBSR – now owned by Morningstar – started touting a different model, under which it researched funds at will and then offered managers the option to promote the resulting ratings for a fee.

With the closure of S&P’s UK fund ratings unit, and the launch of a number of new players in recent years, this is now the prevailing model in use in the UK.

It’s not without its flaws, of course, as arguably the more positive ratings you hand out the broader your potential customer base.

The asset managers revere the agencies, which have internal divides between fund research and research marketing activities

There are other potential conflicts. Many of these ratings firms also carry out certain consultancy work for asset management businesses outside of their ratings activities, for example.

Last November Jim Wood-Smith of Hawksmoor Investment Management slammed the UK’s ratings industry, accusing the system of being “rotten” and part of a “broken process”.

But I don’t think there’s a serious issue of bias in the UK fund-ratings industry.

The asset managers revere the agencies, which have internal divides between fund research and research marketing activities and use technical quantitative screens to weed out poorly performing funds.

They are also never afraid to suspend and review their ratings the instant any management changes occur on funds, often to the chagrin of the fund houses.

That said, I do welcome last week’s news that Fundhouse is launching a new ratings-charging model in which it will receive no payments from fund providers at all. The firm will instead aim to get financial advisers to subscribe to its ratings services for a fee.

The existing agencies tend only to hand out positive reviews – ‘Hooray, you’ve been awarded silver, our fifth rating behind diamond, platinum, gold…’ – or no rating at all, but Fundhouse is likely to rate funds ‘warts and all’.

It has already delivered an interesting negative analysis of Standard Life’s Gars fund, bringing to light concerns that I had certainly not seen voiced anywhere else.

That makes this something rather different, and rather interesting.

John Kenchington is editor of Investment Adviser