Star ratings

Recent missives fired from research houses raise serious questions about the star rating system used for rating managed funds in this country.

Two of these releases condemn two of the biggest names in the retail funds management business, BT and Macquarie. A third release announces the introduction of a six star rating system that defies the five star systems used by Morningstar, InvestorSource and Assirt.

All the star rating rating systems purport to steer investors away from relying solely on past performance to select the funds they wish to invest in. As we all know, past performance has little bearing on future performance and investors who chase returns do so at their own peril. The star ratings supposedly give some insight into the future performance of the fund manager.

So star ratings include a qualitative overlay that delves deep into the investment process to investigate the underlying quality of the investment, not just the one year figures - or at least that's what we're told.

The recent star rating downgrades to both BT and Macquarie follow atrocious Australian equities performance numbers for both managers. Investors, advisers and asset consultants are understandably angry that the funds they had faith in had lost them money.

The point is that star rating systems are supposed to warn investors against these sorts of calamities before they happen not afterwards. BT claims its

investment process was exactly the same when its flagship BT Equity Imputation Fund was rated four stars as it is now it has been downgraded to two stars. The only difference, BT claims, is that the fund underperformed dramatically last year.

If the investment process is the same, why did Assirt take the unprecedented step of downgrading the rating from four star to two star? Sure, the star rating has a one year performance component, but if the process is the same, does it mean the previous four star rating was incorrect? The concern is that downgrading a manager after a bad year might be perceived to be reacting to the poor numbers rather than the underlying investment process.

Despite doubts in the mind of some in the industry over the veracity of star rating system, its success in the minds of investors continues to spawn competitors. The latest is the six star system to be launched by InvestorWeb in a fortnight.

Each new entrant into the star rating market increases confusion in the mind of consumers. It is now possible for an individual fund to have four different star ratings (ie three, four, five and six star) from the four research houses. The danger for the research houses is that the confusion created could render the star rating system meaningless to consumers.

The star rating system in Australia is still in its infancy compared to the US where the likes of Morningstar have made the system known and respected by Americans. The system is developing quite differently in Australia. It will be interesting to see how the research houses juggle the perceptions of investors and the industry.