Dreaming the dream: a perfect ratings house

While nobody’s perfect, Nicholas O’Donoghue asks fund managers what their perfect ratings house would look like, and finds out the flaws in the current crop. 

Fund managers are desperate for consistency in the ratings houses that assess their products, to give them clarity with regard to how they can maximise their ratings. 

While data from the annual Money Management Rate the Raters survey found that the majority of fund managers felt the rating their products received from the five rating houses were fair, some felt that the researchers’ approaches to different types of products were flawed. 

"An ideal ratings house would hire smart and committed people and implement processes to retain them and provide their best people with a career path." - Tim Samway

Inflexible 

A specialist resource-focused fund manager, who spoke on the condition of anonymity, said the research houses had become overly focused on the big four banks and AMP and failed to cater for managers whose products do not fit the categories of the mainstream funds. 

“The whole industry has been set up to service those five customers,” he said. 

“Planners and product providers who are not in those five camps essentially get a rough deal. 

“We’ve been producing an absolute return natural resources fund [and] we’ve found it’s neither fish nor fowl; it’s neither a large cap Australian equities fund nor is it a small companies fund. In the history of our ratings we’ve found our natural resources fund was bundled between absolute return hedge funds, to agricultural products to small companies’ funds.”  

Ratings confusion 

The fund manager said his experience with one ratings house indicated that the analysts conducting the research of his fund did not understand the cycle within the resources sector. 

“[As I mentioned] we run an emerging resources fund, [and in one research house analysis] at the top of the market - the strongest part of the commodity upswing - the time when people should be reducing their weighting in resources stocks and moving [to other sectors] in anticipation of the inevitable downturn, our fund was rated from 'recommended’ to 'highly recommended’,” he said. 

“Cross the cycle - the market’s fallen 60 per cent - we’ve changed from 'highly recommended’ to 'redeem’. 

“It’s extraordinary¨ they’re putting in the strongest recommendation after a cyclical sector’s jumped up so far, and then you’re putting it on a 'sell’ at the bottom of the market.” 

Fresh faces 

The unnamed manager said that while some ratings agencies were better than others, the introduction of new research houses might benefit the market. 

“We might need off-shore ratings organisations to come in with a different agenda, a different way of rating,” he said. 

He said a new ratings house would be “smarter and more receptive to considering different formats” to the one currently used by the major players in the market. 

Analyst experience 

When it comes to a research house analysts experience counts for fund managers, according to Hyperion Asset Management managing director, Tim Samway. 

Analysts for the perfect rater would be familiar with the products they assess, eliminating the need for fund managers to run through the details of the product with new people every year, Samway said. 

“Managers hate having to re-educate new [rating house] staff every year,” he said. 

“An ideal ratings house would hire smart and committed people and implement processes to retain them and provide their best people with a career path. 

“[It would] take time to build up a knowledge bank on and confidence in the managers they review and reflect that in the information they provide to their clients, rather than each years’ rating representing just a current snapshot of the manager.” 

The need for continuity within the research team was echoed by another fund manager from a leading financial services group who wished to remain unnamed.  

“It definitely helps having the same people year on year,” the manager said. 

“Sometimes there’s not a lot of consistency in the people you see year on year, so whether they send in the junior analysts or they send in different analysts every year it becomes hard to build up an ongoing relationship with them. 

“[But] sometimes it’s good to get someone else, because researchers can have their biases as well, so it’s good to get at least one person new over a couple of years, but you definitely want to have some people that have seen you before.” 

Consistency 

Not only would the dream rating house have a low turnover of analysts, but it would also use clear and consistent matrix. 

“[They would] follow a consistent and easy to explain process of rating, so managers are not left guessing at what information to provide,” Samway said.  

The Hyperion managing director was not alone in his call for consistency in the approach researchers take to the ratings process with another manager saying the ideal rating house would be transparent. 

“You want transparency in the rating process,” the manager said. 

“They’ve all got criteria that you’d look at, but there’s no clear benchmark that if you know you’ve got X performance [standard] or X number of people in the team¨ it’s a relative score.”  

The manager added that the provision of feedback would be a key service the perfect rater would give fund managers, to enable them to improve their products year in year out.  

Value for money 

While data from the Rate the Raters survey suggests that the payment models used by researchers impacts fund managers’ perceptions of them, Hyperion’s Samway believes the ability to provide value for money would be a key criteria for a perfect research house. 

“Whether a ratings house chooses to charge or chooses not to charge for their ratings, it still should be able to demonstrate the value a manager receives for the time and /or money the manager invests in being rated,” Samway said.  

“Managers rate their products to help them distribute their products by giving end clients confidence and knowledge to invest, not so a manager can feel good about getting the highest rating.  

“An ideal ratings house would be able to connect the dots between their ratings and the distribution process.”