Rating methods mystify managers

Over the past three years the issue of transparency of ratings methodology has been raised in each of the Rating the Raters surveys conducted byMoney Managementand it is a question that fund managers leap at when it comes to responding.

This year, the managers showed a definite lean towards theAssirtprocess with 72.7 per cent of managers considering the transparency of the process to be ‘good’.

No ratings house recorded a strong vote by managers in the area of ‘excellent’, but strong showings were made byInvestorWeb,Standard & Poor’sandMorningstarin the area of ‘good’ scoring 53.3 per cent for the first two rating houses and 47.1 per cent for Morningstar.

Taken on the balance of all answers across the range of response, the numbers turned slightly with Assirt still leading followed by Standard & Poor’s andLonsecin the top three places.

Looking at the tables it is interesting to note the placings of some of the newer entrants to the ratings space with Zenith, Standard & Poor’s andMercerposting solid numbers in the ‘good’ category.

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Zenith and Mercer also had big figures in the ‘below average’ category but some of this can be put down to their new entrant status and possible lack of familiarity with the house’s process.

The general numbers also reflect a swing by fund managers to regarding research houses as more transparent than in recent years.

In 2002 and 2003 the general trends leaned towards rating houses either being somewhat or not at all transparent with only single rating houses standing above the crowd.

This year’s figures have many more rating houses gathered around the top end of responses and very few at the bottom of the range.

The issue of objectivity was also a contentious one, with few managers seeing total objectivity among rating houses. However, many of them did feel there were high levels of objectivity, but this was tempered with similar figures stating rating houses were ‘somewhat objective’ as well.

This indicates more work needs to be done in outlining the processes but not as much as other areas because very few managers regarded the ratings processes as being completely subjective.

Fund managers also felt that rating houses should cover a wider sample with 95.7 per cent of managers stating it was an important part of the research houses’ work.

But when asked to give a number as to how wide the range should be, answers varied from 10 managers in general, 10 managers per asset class or sector through to 80 per cent of a set funds-under-management figure, and the whole investment universe culled using quantitative overlays.

The issue of quantitative data use, or past performance, struck a chord with fund managers with only 13 per cent seeing no use for it at all and opting for a totally forward looking stance from rating houses when constructing a manager’s ratings.

On the reverse only a handful, at 8.7 per cent, said it should make up a significant part of the process with just over 78 per cent stating past performance should be used but over longer time periods only.

But if there was a large degree of uniformity regarding the use of quantitative data there was much less when it came to the mix between quantitative and qualitative to be used. The average of all views leaned towards a 59/41 per cent qual/quant mix but individual managers’ responses varied from 20/80 to 90/10 qual/quant mix.

However, the demographics of the range show that there was a clustering in the range of 40/60 to 60/40 qual/quant mix and that most large and mid-size managers selected these parameters. The outlying ranges tended to be selected by small and boutique managers, no doubt reflecting the biases and business models of the fund managers themselves.

On that basis, fund managers should seriously question their demands on research houses. This is because there are some fair calls from them over transparency, process and methods. Yet until fund managers can agree on what constitutes an equitable process, research houses will continue to offer their process to the market and defend it while they do, as being what some of the market needs and wants. Much like what the fund managers do with their own products.