There has been some debate about the effectiveness and use of fund ratings; with a 2016 Financial Conduct Authority (FCA) review suggesting that perhaps too much emphasis is placed on them. However, the latest Schroders Adviser Survey in December 2017 demonstrated their importance with just over 70% of advisers surveyed using ratings or a ratings agency[1] as part of their fund selection process. Another study by Platforum in 2017 [2] showed that research agencies influence £210bn of advised fund assets held on platforms, 52% of the total adviser platform market AUA. So why are they such an integral part of fund selection and how can asset managers use them to differentiate their funds?
Fund ratings simplify the fund evaluation process for advisers. There are over 3000 funds registered in the UK and selecting a fund that will best meet a client’s investment goals can be quite challenging. Fund ratings offer a convenient way of filtering the funds by summarising them using broad parameters such a performance, risk scores, alpha and also volatility.
They are also useful for keeping the industry in check. Ratings can encourage asset management firms to stick to their performance targets as well their investment style as poor performance or a big shift away from a fund’s objective might lead to a downgrade in the fund’s rating which in turn, might lead to potential outflows.
However, a fund’s rating alone does not give a definitive prediction of success. A rating is one of many key resources available to advisers to aid them in this filtering process. Despite not being a top tier rated fund, a fund with a lower rating is still more than capable of catching an adviser’s eye. This is because when choosing a fund, the adviser also has to consider the client’s risk profile & investment objective. It may be the case that a lower-rated fund is more suitable than a higher-rated one when considering these parameters.
FE’s research manager, Charles Younes backs this up: “Most fund ratings assess the performance of a fund for a specific short time period. At any point, there could be temporary reasons to explain why a fund could merit a lower rating, such as its style, geographic or industry preferences. If only invested in top-rated funds, you may end up with a selection of funds with similar biases, therefore limiting the diversification benefits in the overall portfolio. FE’s wide range of ratings helps advisers with this. Be it manager ratings or a risk score, they all make for a more informed investment decision by taking the focus away from merely being a top-rated fund.”
It should be noted though, that according to the 2017 Platforum report, advisers generally use ratings to filter funds that are rated more highly with more assets going towards those funds. Despite ratings not being the be all and end all, for an asset manager, this is important because it is likely that the more highly rated a fund, the more chances of it being on an adviser’s shortlist, thereby leading to likely inflows.
Ratings are important for several other reasons; they help advisers to get a balanced and independent view of their potential fund choices.
Furthermore, ratings enable advisers to reassure their clients. In addition to using them for fund selection, an adviser can also present his/her clients with an investment solution knowing that the research they have done is based on reliable information. Moreover, since most of these ratings including FE ratings are freely available to the end investor, it means that they can see the same ratings that an adviser will be seeing, creating a greater sense of transparency.
Lastly, ratings may help an adviser unearth new investment opportunities for their clients. Given the vast number of funds available to an adviser to choose from, an opportunity may have gone unnoticed without the rating pointing out the success of a fund.
There are many ratings agencies in the UK each offering a slightly different system of rating funds so how do you ensure you are using the most appropriate one? An important factor to bear in mind when choosing a ratings agency is to see if it is independent and unbiased in the way it awards its ratings, given the possibility that any rating could direct the adviser in a particular investment direction. In addition, the methodology used by the ratings agencies must be stringent and impartial.
There have been recent accusations of agencies rating funds for money thus skewing the results. At FE we do not charge anyone to have their funds rated and all our ratings are awarded independently and are truly whole of market. We believe fund ratings play an important role in supporting accurate and fair comparisons of funds, managers or groups and therefore should not be influenced in any way. Ultimately ratings play a huge and important part in making the market more transparent and accessible and in helping people make better investment decisions.
[1] Schroders Adviser Survey 2017
[1] UK Fund Distribution: The Influence of Research Agencies
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