Value of ratings questioned
Ratings of complex financial products need to be taken with a "grain of salt", according to WHK Group head of research Jeremy McPhail.
"People have a lot of confidence in that information and that guidance, but you've got to understand that they're never going to get everything right, and that's no different for managed funds or direct stock researchers," he said.
Research houses do not align ratings with an investment philosophy nor the objective of a client, he added.
McPhail said he had noticed discrepancies in research data on fixed income products, and so the research team split them into true fixed interest and enhanced yield categories.
Complex products like collateralised debt obligations failed to make it past the selection process, he said, as the investment team couldn't get comfortable with what the underlying holdings were, despite its high rating.
"They were certainly more opaque and less transparent (in terms of) what they were actually holding and investing," McPhail said.
Recently, Lehman Brothers/Grange Securities was charged over the distribution of synthetic collateralised debt obligations to a number of local Australian councils. Legal firm King Wood and Mallesons believed it was the first such institutional case - and could be the first step in a series of actions on complex products.
Zenith Investment Partner national sales manager John Nicoll said retail clients' demand for structured products had waned and there were very few - if any - at the moment that Zenith had rated.
"We look at them very closely and just by their very nature, they're less likely to get through a research process because the advisers need to be able to explain it to their client," he said.
It was important that research houses included risk indicators, but dealer groups should also have some understanding of where the risks lie.
InStreet managing director George Lucas said investments committees use research reports as just another input when considering complex retail products including hybrids.
"Hybrids are probably the most popular retail product in recent times, and they're gaining a lot more acceptance in portfolios than, say, they would have a couple of years ago, as an alternative to get stronger yield," he said.
He said the research process is longer with complex products - not because they necessarily carry greater risk, but because teams may be unfamiliar with the product.
"You've never seen this product before. With BHP, for example, you've had a history of looking at it for the last 30 or 40 years and you're just putting incremental knowledge on. When some of these hybrids come out, you've got to start from scratch," Lucas said.
Issues such as tax and regulation risk are the same for all types of investors and products, he added.
One of the reasons the regulator is targeting complex products is due to poor market returns, but Lucas said Australia had a very strong compliance regime.
"It's not because the product has been mis-sold; it just means that the underlying market hasn't performed and investors' expectations haven't been met," he said.
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