Report card for the researchers

Fund managers have once again been given the opportunity to give their frank but anonymous assessment on the research houses that so frequently determine how the financial services community perceive their products through participation in the annual Money Management Rating the Raters survey for 2006.

Over the past 12 months the landscape for the major research houses has changed significantly, with the full year presenting a sufficient time period to see what effect the sale of Assirt to Standard and Poor’s (S&P) has had on the industry, and how the strategic alliances formed between van Eyk and some of the more specialised researchers have been received.

Overall, fund managers still viewed the raters in a positive light and acknowledged that the influence the researchers had on the industry remained significant.

However, major concerns over conflicts of interest continues to linger among fund managers, as do calls for greater transparency regarding the whole ratings process.

Frequency of use

Table 1 shows most fund managers have asked for their products to be rated by the various research houses over the past year.

The purchase of Assirt by S&P from St George appears to have been successful in boosting this researcher’s market presence, as 57 per cent of respondents had been reviewed by this house in the 12 months to March 2006 as opposed to only 32 per cent for the corresponding 12 months in 2005.

However, despite this result, one respondent did not see rationalisation as something the industry would experience in the near future.

“I don’t know if it will rationalise too much further. If it starts to consolidate then you’ll get some new boutiques that see they have an opportunity to make it out in the marketplace.

“Research right across the board, not just external research houses, has significantly increased in the last couple of years and there has been a higher level of research analyst turnover than the natural long-term average. On that basis, I can’t see a massive consolidation happening,” he says.

Lonsec was the most popular researcher with 68 per cent of respondents revealing they had been rated by this firm in the past year.

But one participant expressed frustration at not being able to be rated by any of the researchers no matter how hard his organisation tried to engage them in the process.

“We have supposedly been on the lists of many of the researchers. We ring, cajole, and beg, but they don’t come,” he says.

Research methodology

The majority of respondents expressed satisfaction with the research methods being employed by the raters, with 53 per cent believing the methodologies involved were either excellent or good and 38 per cent feeling they were average. Only 3 per cent of participants believe the methodologies in use are below average and none suggested they are poor.

While the general consensus was that the methods being used for research were good, one fund manager favours greater consistency of methodologies across all of the raters.

He says: “You seem to get different variances across all the different ratings agencies. One person says you’re fantastic and another says you’re lousy and I think that comes down to the fact that there is no standardised methodology they use for all of us,” he says.

“From a fund manager’s point of view, it’s a little frustrating that they’re each picking out different things and assigning more weight to that item over another. When a fund manager is being interviewed, we’ve got precise guidelines to follow, but on the ratings side of things the assessment can be so subjective and that subjectiveness comes from either past history, personal bias or style.”

Another respondent thinks research houses need to look at the amount of change each ratings revision produces and the practical effect that has on fund managers and in turn investors.

“If the change in ratings is 30 per cent each year it will become quite onerous for the adviser groups relying on that to implement on their approved list. Also, if the advisers want to retain consistency in their clients’ portfolios and have to sell funds down as a result of a revised rating, there could be significant capital gains issues to address,” he says.

“If they feel that the capital gains can’t be justified, the adviser will have to direct cash flow to the newly, highly rated manager while leaving the existing assets in the old manager. This could lead to the situation of having to put a new manager in every year, which in turn could result in a tail of fund managers within an investor’s portfolio and ultimately result in a meaningless portfolio,” he adds.

Another fund manager wants the research houses to improve their turnaround times.

“Most of the research houses are very weak in terms of turnaround times on research ratings. Months go by after research is conducted before ratings are released with little communication on expected output dates,” he says.

Transparency

The research houses appear to have improved in making their methodologies more transparent over the past year, as 44 per cent of respondents thought their approach to this issue was good while 41 per cent thought it was average.

These results compare favourably to last year’s survey, when only 40 per cent of fund managers thought the raters were doing a good job in this area and 20 per cent felt their ability to address this need was below average or poor.

A small proportion of participants, 3 per cent, even considered the raters to be excellent in this regard in 2006 as opposed to no-one expressing this view in 2005.

However, despite appearing to have raised the standard in this aspect of their operations, fund managers still expect more from researchers.

One manager suggests an area of transparency that could be improved is the level of feedback provided to fund managers after a rating has been issued.

“They give you these vague reasons for the rating awarded. We want them to tell us the absolute truth rather than have them hide behind confidentiality reasons. Is it confidential when we have to fill in all of the information for them? It seems to be all one-way traffic,” he says.

Personnel

The quality of personnel employed by researchers continues to be regarded as an important ingredient in determining the level of comfort fund managers have with a particular ratings house.

Respondents seem to be pleased with the depth and level of experience of the people hired by the raters, with 59 per cent believing that this characteristic of the ratings firms was good. A further 28 per cent of participants thought the research personnel in the industry were average.

The results reflect the researchers’ commitment to employing quality staff with one of them reiterating: “We really do hire high quality people with experience in funds management and they really do work hard to try and put their views forward so our clients know what that view is, whether it be on markets, or on many fund managers, they’re in no doubt about our view.”

But while the quality of personnel was not questioned by fund managers, one of them did raise concerns over staff turnover and its consequences.

“There has been enormous turnover in the industry over the past 12 months resulting in inconsistency in ratings from a number of research houses,” he says.

Capabilities and influence

Most respondents feel the raters have a high level of understanding when it comes to the businesses and products of fund managers in the market. This sentiment was reflected by the 50 per cent of participants who believe the research houses have a good ability to reflect fund managers’ investment capabilities.

On top of this result, 38 per cent of respondents think the raters’ capabilities in this aspect are average.

Following on from these observations, 44 per cent of fund managers feel the researchers’ ability to influence the funds flows in and out of their businesses is good, with an additional 34 per cent believing the raters’ influence is average.

However, one manager feels the growing emphasis on the use of platforms among investors and dealer groups may see the ability of the external research houses to influence inflows and outflows eroded in the future.

“The dealer groups currently will use someone like van Eyk or an alternate to build up their recommended list and their preferred list. But almost always they will then go through a platform. So the only funds they are able to use are funds that are on those platforms.

“The only people that influence the platform list are the platform analysts. Well in excess of 90 per cent of funds flow now are going through the platforms and if you’re not on the platforms list, people aren’t going to use you,” he says.

“If the dealer group was prepared to say ‘instead of van Eyk we will now rely on the research capability of the platform operator’, that could well change the influence the research houses have on the industry.

“It’s changing the balance and those platform analysts have assumed a heightened role because of their ‘gate keeper’ capability that’s not yet properly been recognised in the market,” he adds.