A number of smaller asset management groups have told Investment Week of their frustration with ratings agencies, following a report by Fundscape and gbi2 criticising some ‘gatekeepers’ for ignoring lesser-known names.
The Gatekeepers Report, published last week, found buy lists and rankings from fund ratings agencies may be misleading, as they do not always include vehicles based on their quality and longevity of returns, and tend to favour the big household names.
Graham Bentley, MD at consultancy gbi2, said: “The importance of research in fund selection is undeniable, but there are significant differences in the quality of the research processes we reviewed.
“There are plenty of funds that deserve to be on the lists, but there were also some that had less performance substance and more reputational and sales momentum.
“We were also surprised by the number of funds that were clearly strong candidates for inclusion, but were overlooked by some independent researchers.”
The fact that a group is not a household name should not have a bearing on whether an adviser invests in the fund, but unfortunately it does. It is not the fault of the ratings companies.
Representatives from a number of boutique asset managers have since told Investment Week they have experienced difficulties getting in front of ratings agencies due to their small size, but most are wary of openly criticising the current system as they do not want to aggravate key gatekeepers.
According to Bella Caridade-Ferreira, chief executive of investment research house Fundscape, gatekeepers (including those controlling direct-to-consumer buy lists, ratings agencies and off-platform lists) are estimated to control between 50% to 70% of UK fund flows.
One sales representative at a boutique investment firm, said: “I believe ratings are an essential thing, but due to costs and the fact that agencies do seem to edge towards the larger names, we feel slightly pushed aside, which does cut us off from 75% of the market.
“On half the calls we make, fund buyers want to hear we have a rating from one of the big agencies.”
The average cost of a licence to display a fund rating on marketing material is approximately £5,000-£10,000 per annum per fund for each ratings agency (rising as high as £40,000 for a larger asset manager), although there is no initial cost involved in having a fund rated.
However, smaller groups argue that some agencies, especially the bigger ones, do not want to begin research on funds before they have a guarantee a firm will want to pay for the licence.
“When it comes to doing the research, we provide all our information, but it seems like they almost want a guarantee of payment beforehand,” the source told Investment Week.
In response, ratings agencies have denied they are biased against smaller firms, and say their analysts have “independent discretion over which funds to select for coverage”.
There are plenty of funds that deserve to be on the lists, but there were also some that had less performance substance and more reputational and sales momentum.
Lack of understanding
Another issue raised by boutique firms is many run specialist strategies, which can fall under the radar of some agencies. A source told Investment Week one particular ratings agency did not understand the strategy of one of its products, and did not rate the fund for that reason.
A source at another boutique firm agreed, saying: “[The process] involves big questionnaires, meetings, then things go quiet and they do not give a good reason why.
“One said to us ‘the investment objective is too woolly and we do not want to rate multiple funds in the same sector’, so they chose the larger one. You cannot get upset by it. I would rather have people who understand the fund investing in it.”
For newer firms, another problem is agencies want to see long-term track records, but on the flip side they tend to focus on three-year numbers, which can be a problem for private client funds in particular.
These firms have said they feel excluded because their products tend to focus on longer-term performance, and although many vehicles have weathered the storm of 2008, agencies often disregard this in their research.
Buy list concentration
However, many also acknowledge the issue of fund flow concentration cannot be blamed on ratings agencies alone.
One source believes the fault lies with the regulator for forcing advisers to do so much due diligence they have no time to research individual funds, so only buy those with a rating from one of the big agencies.
“They will have a filter on whether or not it is rated, so we will be discounted immediately without them even looking at our objective or performance,” he said.
“The industry has lost sight of taking responsibility for investing in things you understand; instead they are just picking off a buy list.”
Mark Thomas, MD at River & Mercantile, added: “I think the ratings firms do look across the board for the best managers but the reality is it is up to the team building the portfolios what goes in and they tend to go for the larger, well-known names.
“The fact that a group is not a household name should not have a bearing on whether an adviser invests in the fund, but unfortunately it does. It is not the fault of the ratings companies.”
On half the calls we make, fund buyers want to hear we have a rating from one of the big agencies.
Ratings agencies respond
Oliver Clarke-Williams, portfolio manager at FE
We rate all funds available for sale in the UK with enough history, regardless of size. In terms of ratings, all funds are eligible, no fund is excluded and no group has to pay to be rated. This ensures that the ratings are whole of market and independent.
However, it would seem logical in instances where groups have to pay to be rated that large groups will be more prevalent as they have bigger marketing budgets and can therefore pay for more ratings.
Clive Hale, director at FundCalibre
We do not agree that ratings agencies are overlooking smaller companies, at least not in the case of FundCalibre. If you take a look at the houses whose funds we rate, you will see that around 50% are those with less than £5bn retail assets under management. About 20% have less than £3bn. We continue to get inquiries from even smaller groups and are currently evaluating a couple of funds from a house with less than £1bn.
Victoria Hasler, head of research at Square Mile
At Square Mile, the size of a company is of very little importance to us when recommending a fund. We do make sure that all funds have the requisite resources, including adequate levels of investment and support personnel, as well as systems, IT, compliance and anything that we feel they need to be able to run a fund.
The size of the company is not of huge importance in determining how often we meet them. Some small companies have large and relevant fund offerings, some large companies have only a few relevant funds.
Ken Rayner, founding director at RSMR
We do get a few phone calls with smaller fund management groups and we try to be as sympathetic as possible to that. We have always taken a view that when it is good enough, it is good enough, hence why we have fund managers like Unicorn, Chelverton and Evenlode on our list.
However, some funds can capture the strongest of their performance in the early part of their life, so often it is a mistake not to wait until it is £500m in size before looking at it.
A spokesperson for Morningstar
Our manager research covers the funds most relevant to investors. This means funds of significant investor interest or those that our analysts believe have investment merit. Our Manager Research Analysts have independent discretion over which funds to select for coverage; there is no minimum size requirement.