Risk of relying on fund ratings

Risk of relying on fund ratings

Advisers may face years of uncertainty, volatility and the chance that many of their clients’ outcomes will not be achieved.

No, this is not a preamble to another tiresome Brexit scare story. Hiding in the shadows of that rather lurid spotlight there are deeper issues that need to be addressed if UK investors are to achieve the outcomes they seek.  

The savings ratio is the proportion of our disposable income that is saved rather than spent. During the 1980s and 1990s, we parsimonious Brits stoically squirrelled away more than £13 for every £100 we earned.

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That figure has steadily declined over the past 25 years. Today, according to the Office for National Statistics, we save less than £4 in every £100. Meanwhile, those savers face the prospect of their savings having to last longer. In 1940, a male retiree expected to live fewer than 11 more years when taking the state pension at 65. Today, that expectation is more than 20 years. A 45-year-old in 2016 might have to fund a retirement of more than 25 years.

People are saving less, to fund a retirement that will last longer.  

Compounding the issue, the returns savers might expect are likely to be substantially lower than those experienced by today’s retirees. Forty years of asset price re-rating were driven by interest rates and inflation falling from 17 per cent and 24 per cent respectively, to virtually zero today.

There is unlikely to be such a driver of asset prices for decades to come. We are absolutely destined to occupy a generally lower return environment. Consequently, today’s investors need to save more and work for longer, while seeking out exceptional returns.

This is where advice comes to the fore.

The suitability imperative requires advisers to have a robust investment process, generally focused on client risk profiling and asset allocation. However, customers’ investments must seek to produce outcomes over time beyond their minimum acceptable return (MAR) – that which is required to achieve their goals – plus associated costs of administration, and any advice. The more mouths there are to feed in the investment value chain, the higher the total cost of ownership (TCO). The higher the TCO, the less likely it is that investors’ objectives will be achieved on schedule.

Increasing returns beyond the beta expected via asset allocation models requires alpha generation via the underlying securities and funds. A robust fund selection programme is no less important than an asset allocation process, and for many advisers this may be their greatest area of business risk.  

Despite the availability of specialist fund research companies, about 70 per cent of advisers continue to claim to select funds and build portfolios themselves. Most of those advisers are unlikely to have full-time, experienced fund analysts, and fund managers are unlikely to give them the same attention they would the commercially significant research companies. 

Consequently, many advisers refer to "free-to-air" ratings awards collated by services such as Morningstar, RSMR, Citywire and Square Mile. Research on ratings services and analysed recommended funds lists from more than 40 ratings agencies, advisers and platforms is clear that the use of researched lists has three key advantages: