Not all ratings created equal: S&P

Advisers have been warned against making simplistic comparisons between fund ratings from the different research houses in the Australian market.

In a white paper on ‘Deconstructing fund ratings’, S&P Fund Services managing director Mark Hoven (pictured) said important differences between fund ratings could exist “even where two research houses use the same ratings scales”.

He said while a “diversity of fund ratings opinion is healthy for the market”, the diversity puts an onus on advisers to understand the differences between ratings in order to be able to use them appropriately.

Hoven warned that even where two research houses use the same scale, “a closer inspection may show meaningful differences in the way that research houses assess funds and assign fund ratings”.

“Until these differences are fully understood, treating all fund ratings in the same way runs the risk that advisers may use fund ratings in ways that were not intended.”

Hoven suggested advisers consider a number of underlying elements of fund ratings to enable an effective comparison where more than one research house is being used — as is the case in most advice practices.

He described ratings objectives — the basis upon which a research analyst assesses an investment — as “arguably the most important building block and where differences between research houses are overlooked”.

Hoven said advisers should investigate what elements underpin the assessments of each research house they use to ensure they are using fund ratings appropriately.

Another point of difference between Australian research houses is the peer group definitions they use. Hoven warned “fund ratings can be compared within a peer group, but not across peer groups”.

“For example, a highly rated Australian equity large cap manager cannot be compared with an equally rated emerging markets equity fund. The level of risk attributable to different asset classes is often misunderstood by investors who may look at the fund rating in isolation, rather than the level of risk inherent in an investment and whether it is appropriate for them.”

Also of concern is the fact that there remains confusion between qualitative and quantitative rankings, particularly when “scales used on fund ratings and rankings, typically ‘stars’ in Australia, are the same”.

The full white paper, ‘AA Highly Recommended 5 Star Fund: Deconstructing Fund Ratings’, will be published in an upcoming edition of Money Management.