Retail research houses, which deliver ratings on funds management products, have a strong influence on investment flows. That is no surprise, but is it warranted?

A survey published by trade magazine Money Management last week found that 44 per cent of funds managers believed the ratings firms had a “good ability to influence a funds manager’s cashflows”. More surprisingly, given the anonymity of the survey, 50 per cent believed the ratings firms had “a good ability to reflect a funds manager’s investment practices”. My contentions are: • That 44 per cent believed the ratings firms influence fund flows is a low proportion. Most funds management marketers see the attachment of a ‘rating’ from at least one of the well-known research firms as a necessity in going to the planner market. • That half of managers believe the ratings firms are good at assessing the managers’ practices is a high proportion. Anecdotal evidence would suggest that managers are not so generous in their views of the ratings firms’ abilities. Without wanting to be critical of the survey, which is a worthwhile exercise, the managers’ views on the influencers of funds flows needs to be taken in context with other factors, in particular investment performance. There is little doubt that over a long period of time, there is a high positive correlation between good retail ratings and good past performance. That correlation is probably higher than is the case for recommendations from institutional asset consultants and managers’ past performance. The former managed funds researcher, now the chief investment officer for Select Asset Management, Dominic McCormick, once told a conference on masterfunds that there was a “disconnect” between retail ratings firms and institutional asset consultants. Citing the examples of the former BT Funds Management and Colonial First State for Australian equities in the late 1990s, he said that the retail researchers were slow to react to the capacity problems faced by both managers at the time and other factors, such as staff changes, which would likely impact on future performance. In Colonial’s case, in particular, he said that the manager was garnering strong retail flows, following a period of good investment performance, but had attracted relatively little institutional funds because the asset consultants were wary of recommending the manager’s Australian equities capabilities. While it is not helpful that participants in the institutional marketplace are often perceived as elitist, there is overwhelming evidence that the institutional asset consultants, with superior resources, produce research of greater depth and sophistication than the retail ratings firms. They not only tend to have greater resources, they also concentrate their efforts more. Asset consultants study managers’ capabilities whereas retail researchers approach the task from a product perspective. Since it entered the market, however, Standard & Poor’s, which also has a small asset consulting arm, has changed the process of the former Assirt such that managers’ manufacturing capabilities are given more attention alongside assessments of their products. Another interesting point in the survey, which involved 43 funds management firms, is that there is concern about possible conflicts of interest at the retail firms between their ratings and other sources of revenue. The managers were concerned about firms which also had investment products and those which were owned by a financial institution. However, Lonsec, which is owned by Zurich, was rated highest for the quality of its research, followed by van Eyk and Morningstar in equal second place. Of the four largest ratings firms, Morningstar and S&P, are owned by US research firms, and van Eyk by a group individuals primarily consisting of directors and management. Since S&P acquired Assirt, and severed the ownership link with the Asgard masterfund, only van Eyk and Lonsec have links to investment products through their firms’ ownership. Among institutional asset consultants, the potential for conflicts is probably greater. If implemented consulting is considered an investment product, four of the six largest – Russell Investment Group, Mercer Investment Consulting, JANA and Intech Asset Consulting – have investment products offered by their owners, leaving Watson Wyatt and Frontier Investment Consulting to provide consulting services (advice) alone.

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