Research houses go under the spotlight

Nearly a decade ago, Money Management published the results of what was called the Pratt Survey on the attitudes of funds management groups towards research houses. Much has changed in that time, including a number of the players, but a few key issues have also remained central.

It is these issues - the methods behind the research, ethics and integrity, and the value research can offer - that have continued to be debated and questioned since that last survey in 1993.

However, the time has come for the funds management industry to speak again, this time through The Money Management Rating the Raters Survey. Interestingly enough, in many instances the complaints and comments received were first uttered some nine years ago.

The research houses can be proud of much of what has been achieved and the industry has identified that as well, especially in the areas of defining qualitative versus quantitative analysis and its use in the industry. According to the survey, this split is widely accepted, even if not always fully understood.

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However, the funds management industry has for some time been critical of research houses, usually after a spate of poor rankings has hit some of the bigger players in the industry. No one likes bad news being spread about them, especially from a group they may have paid to discover such information.

This unusual relationship has been further highlighted inTheMoneyManagement Rating the RatersSurvey, which polled the perceptions of funds managers currently accounting for 80 per cent of the retail funds under management.

The results revealed 70 per cent of funds management groups involved in the survey have a role dedicated to managing the research process, reflecting both the perceived importance of research and the fact that more than two-thirds of the Australian funds management industry is rated.

However, when asked to give overall impressions of the capabilities of research houses, 57 per cent of respondents felt they were average. The remaining funds managers were evenly split, with nearly a quarter saying research house capabilities were either well above or well below average.

On an individual research house basis, van Eyk stood out with 44 per cent perceiving its capabilities as sound (Table 1).

Taken as a whole, these results indicate that only a quarter of the industry feels research houses are doing outstanding work, yet 70 per cent of those involved in the survey pay for the research to be carried out.

These two results are brought into further focus when funds managers were asked to judge the transparency of the methodology of each research house. Once again the middle ground was most common (65 per cent), with only 15 per cent confident the research house processes were totally transparent. The remainder labelled the processes as not transparent at all.

Morningstar was the notable exception, without a single manager stating its process was not transparent (Table 2). This was highlighted last year by Frank Russell managing director Alan Schoenheimer in a presentation on star ratings. Schoenheimer emphasised his use of Morningstar data was driven by the fact it was available and easily dissected because the process was made public on an ongoing basis.

Levels of transparency also echoed the response of managers when asked to consider whether the results of the various research processes were subjective. Once again most managers felt research results showed no clear leaning to either being highly subjective or totally objective.

In regards to the mix of qual versus quant, funds managers were not as critical, once again reflecting their own biases when asked what the mix is for each research house and then the ideal industry mix.

Not surprisingly, the two dominant models of 50/50 and 75/25 came to the fore, despite some respondents wanting either purely quant or qual at all times.

What was just as interesting was how the industry voted when asked of the importance of sector or manager review being the most effective. More than 70 per cent of respondents opted for sector review, in which a sector such as equities is covered across all managers, while manager review, in which a manager is rated across all sectors, was given a definite second place.

However, The Tom Collins Consultancy chairman Tom Collins says the survey participants from larger fund managers preferred this option because of possible negative returns that may occur within an individual product. Also, sectors are rated at the same time while managers are rated at varying times, making it difficult to compare funds management groups due to differing market events.

Collins also says those boutique managers involved preferred a manager review, as they are keen to promote the expertise of their group.

In spite of these possible biases by respondents, 90 per cent still felt that product and manager research was essential in reviewing a manager, once again reflecting the qual focus present in the local research industry.

The quant focus though was never too far away either, with 85 per cent of respondents indicating there should be some measure of past performance influencing the managers’ ratings, despite comments in the past by both fund managers and research houses that past performance is no indicator of future performance.

Nonetheless, while the industry has the choice in various research processes, it seems keen to maintain it, with 60 per cent of respondents rejecting a call for only one review process in managed funds research.

Collins says that if the number was limited it could dictate research terms to the market, but on the other hand, the presence of numerous processes easily allows managers to hunt through the market until they can find a positive rating.

This touches upon the issue of whether research houses are accountable for their recommendations, with nearly two-thirds of funds managers responding they were not, and 90 per cent calling for greater disclosure, particularly in the area of ownership and financial influence.

Yet in regards to the issue of whether the payment of fees compromise the outcomes of research, the industry was almost neatly split up the middle with 50 per cent stating it did, while 40 per cent said it had no affect, with the remainder unsure.

Funds management respondents were as ambivalent about the difference between services offered by research houses, with 65 per cent stating they were not clearly differentiated. A quarter were uncertain, while only 10 per cent felt there was a clear difference.

Collins says the problem here is that while research houses feel they differ, funds managers do not see it, so it is more an issue of research groups promoting themselves than any failure on the part of funds managers.

So doesThe Money ManagementRating the Raters Surveyresponses reveal a research house that stands out above the rest? In short, no. In a number of areas some houses did better than others, but according to the funds managers who took part, there is no research group that dominated across the board.

It is clear though that the relationship between those who supply the research and those who seek it to validate their product and work remains as unusual as it did nine years ago.

Research houses are said to have too much power and are in need of regulation, yet at the same time they provide services that allow managers to benchmark their own business and gain insights into others.

Unless some radical change takes place within the world of managed funds research, it appears this will be the landscape the industry must face, at least in the short-term.

—Jason Spits