UKJan 16 2017

Quant ratings do help ‘separate the wheat from the chaff’

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The FCA Asset Management Market Study interim report piqued the interest of most participants in the asset management industry. Its wide-ranging findings left very few stones unturned as it addressed fund pricing and performance, the value of platforms, intermediaries, consultants and ratings agencies.

The report highlighted the influence of third-party ratings on investor decisions, concluding among other things that funds with high quantitative ratings “do not significantly outperform benchmarks net of charges”. 

This report should be welcomed, and it certainly highlights important issues.

While the debate around potential conflicts of interest regarding qualitative ratings agencies will no doubt continue, in light of this study it is also important to highlight the role that purely quantitative ratings play.

A quantitative sample of the available fund universe is essential; there are simply too many funds for any adviser or investor to analyse thoroughlyJake Moeller

There are myriad funds a UK investor can access, with more than 7,000 products being registered for sale. This presents investors with the challenge of finding vehicles that can meet their needs and add value to their portfolio.

Quantitative ratings are invaluable in separating the wheat from the chaff, of which the first key benefit is the classification of funds into relevant peer groups. There are more than 200 Lipper classifications for products registered for sale in the UK, so investors can be certain they are making meaningful comparisons of like-for-like funds.

In this vein, the FCA report cited performance against benchmarks, but the majority of benchmarks are indices that do not provide a real-world comparison. However, generating quantitative rankings across peer group averages takes into account trading costs, expenses, and movements of investors’ money, the reality of mutual fund mechanics and investing in the market.

Quantitative ratings can consider differing metrics, including total return (how much money was made or lost?), but also consistent return (is performance relatively bumpy or smooth?), preservation (how much does the fund’s value swing about?), and expense (is the fund relatively cheaper or not?). 

This allows investors to avoid the mistake of selecting a portfolio simply because it has a high rating in one area. Seeing a fund from multiple angles ensures investors are better informed.

A quantitative sample of the available fund universe is essential; there are simply too many funds for any adviser or investor to analyse thoroughly. Quantitative ratings provide a starting point for complementary qualitative analysis, which can incorporate a client’s specific predilections. 

The FCA report states: “Past performance does not help investors identify funds that are likely to outperform in the future.” The reality is that past performance reveals a considerable amount about potential future outcomes.

No quantitative ratings system is a panacea. However, a Thomson Reuters Lipper study found that funds with the highest three-year ratings on average for total and consistent returns at the end of 2012 did indeed perform better during the following three years.

Jake Moeller is head of Lipper UK and Ireland research at Thomson Reuters Lipper