Criticisms by van Eyk Research chief Mark Thomas of the levels of scrutiny being applied by research houses have sparked a strong response from rival research houses, writes Lucinda Beaman.
The chief executive of van Eyk Research, Mark Thomas, fired a broadside at the Australian investment research industry last week, criticising his peers for failing to apply high levels of scrutiny to fund managers that pay for ratings.
The statement sparked a war of words among researchers, who argued the statistics distributed by van Eyk Research were unfairly skewed towards Thomas’ group and failed to take into account the different ratings processes employed in the industry, which ultimately influence ratings outcomes.
In his statement, Thomas claimed research houses that are paid by fund managers to rate products do not apply as critical an assessment of those managers compared to those with a subscriber-pays model.
Thomas asserted that research houses that do not derive their income directly from fees for investment ratings are almost two and a half times more likely to critically assess the performance of fund managers.
Specifically, Thomas compared the performance of his research house with that of four of the other research companies: Lonsec, Morningstar, Standard & Poor’s (S&P) and Zenith Investment Research.
Thomas based his assertion on an assessment of the number of endorsements issued by the five ratings houses. The figures were based on 386 fund strategies rated by van Eyk Research, 410 by Lonsec, 554 by S&P, 303 by Morningstar and 559 rated by Zenith.
Of those funds, Thomas said van Eyk Research rated 52 per cent as ‘investment grade’, compared to 87 per cent for S&P, 89 per cent for Lonsec, 93 per cent for Morningstar and 95 per cent for Zenith.
Thomas said the figures proved his group offered research “free from any commercial considerations”, although he failed to address the fact that van Eyk Research does outsource some of its work to Adviser Edge — a group that does accept payments for ratings.
Thomas is working hard to define the value added by his company in an environment where many of its key contracts are under review, but the topic remains one of critical importance to the financial planning industry generally.
Thomas argued the evidence he presented ‘conclusively’ proved that van Eyk Research takes a tougher line than its competitors, a statement that was unsurprisingly disputed by his peers.
Morningstar co-head of fund research Tim Murphy said a more important benchmark to consider was the number of funds given ‘recommended’ and ‘highly recommended’ ratings from the various research houses — rather than simply ‘investment grade’ ratings.
Based on the figures compiled by van Eyk Research, Morningstar ‘recommends’ or ‘highly recommends’ 43 per cent of funds, van Eyk Research 30 per cent, S&P 52 per cent, Lonsec 72 per cent and Zenith 95 per cent.
“It’s a clear differentiator — the three guys [S&P, Lonsec and Zenith] that are paid by product providers to rate products recommend more than half the products they cover,” Murphy said.
Zenith’s John Nichol rebutted Thomas’ argument, saying Zenith’s approach included a detailed screening process that saw only the top 25 per cent of fund managers qualify for ratings — and as such its ratings would be skewed towards positive endorsements.
“We eliminate 75 per cent of the universe in the initial screening process. If we include those figures into that — it makes an entirely different figure,” Nichol said.
“Clearly, because of that system, we’re only going to get a higher proportion of well rated funds because we’ve already eliminated all the duds.”
However, Morningstar’s Murphy questioned this argument as well.
“So if S&P and Lonsec rate more than 500 funds — how hard are they actually screening?”
S&P Fund Services managing director Mark Hoven described the analysis presented by Thomas as “over simplistic and the conclusions tenuous, at best”.
“Put simply, a research house’s business model is only one factor, amongst many, that ultimately drives ratings distribution,” Hoven said.
“Rating distribution is as much driven by the decisions a research house makes about which part of the market they want to cover, their screening process, analytical approach, and whether or not they force a ratings distribution, than by any simplistic correlation with how they get paid.”
Hoven acknowledged that there is “some truth to the fact that managers that pay for ratings will put their best funds forward to be rated”, but insisted S&P analysts “call the ratings as we see them”, which he said was evidenced by the number of ‘sell’ or two-star ratings issued by S&P.
According to the van Eyk analysis, S&P, Lonsec and Morningstar each have around 10 per cent of funds ‘on hold’ or ‘avoid’, compared to only 6 per cent for van Eyk Research.
Van Eyk’s competitors pointed to the fact that van Eyk supplements its subscription income stream from other sources, including its fund of funds product, Blueprint.
“The truth is that all research houses in Australia are paid by product manufacturers in some form, whether this is directly or indirectly,” Hoven said.
“Potential conflicts exist where ever money changes hands. What is important is how these conflicts are managed.
"Wealth management groups and their advisers need to move beyond simplistic assumptions and ask their research houses some critical questions about how they manage potential conflicts, whatever business model they follow.
"This is what will raise the bar across the entire research industry.”