Stating the facts on third-party ratings

In our estimate, around 80 per cent of advisers rely on fund ratings to guide and inform their fund choices, making it a very important service to the industry.

Yet in spite of the widespread use and reliance, the recent FCA report suggests that there was no real evidence of added value.  

The report looked at best buys lists and found: we note that after costs even these funds have not outperformed their benchmarks.

They also looked at mainstream positive qualitative ratings and found: net-of-fees excess returns are statistically indistinguishable from zero over various different holding periods.

And they looked at (five star) quantitative ratings and found: after charges the returns above the benchmarks are statistically indistinguishable from zero.

Imagine giving a negative rating on a flagship fund, knowing the fund group is a big client.

This is the first fact: ratings are really important, but it seems there is little evidence that they add any value.  

The second fact is that there appears to be no accountability for fund ratings – so this lack of added value can linger.

At least with asset managers, they publish a track record and this gets scrutinised to separate out good from bad. But fund raters don’t tend to do this and it should be a main indicator of whether we have any skill in finding good funds.

Furthermore, fund ratings tend not to be regulated. So evidence of value added is zero, but nobody is rating the raters. This feels lop-sided in favour of the rater, not the client. 

The third fact is that fund ratings providers are conflicted. In a recent article, we saw how fellow fund raters took such exception to this accusation. But, it is a fact – ratings are conflicted.

The lady doth protest too much, me thinks. Does anyone perhaps wonder why fund ratings are generally free? It is because the real fee-paying client is the fund manager, whose funds they rate.

This is what the FCA said on it: “Some ratings agents have a conflict of interest as asset management firms pay them a fee to use ratings in marketing material and to access other services.”  We can be willfully blind and dispute it, but it’s a conflict in plain sight.  

This brings us to the fourth fact. If only 40 per cent of active fund managers outperform (in our estimate), why are nearly 100 per cent of ratings rosy and positive? Is it because fund raters have a cosy relationship with the fund groups, perhaps? Imagine giving a negative rating on a flagship fund, knowing the fund group is a big client. We couldn’t find any such examples.

But, I should declare that Fundhouse has a vested interest in saying all this – we are a third-party fund rater and don’t ask fund groups for these subsidies.

We are also regulated for fund ratings, have a track record our clients can see and many of our ratings are negative.

However, we believe any fund rater who says they are not conflicted, yet receives marketing fees from fund groups, is wrong.

The facts say otherwise. If we can eliminate conflicts and add accountability, the odds of us demonstrating added value to clients can only increase. But, for now, the FCA report should leave us all embarrassed, introspective and apologetic.

Rory Maguire is chief executive of Fundhouse