Lonsec seeks to allay ASIC's research house concerns

With ASIC questioning the dominance of research houses when it comes to retail usage of private market funds, a research house has shared the factors when it ranks these types of funds.

In the regulator’s private market report in September, it discussed the growing volume of retail investors who were accessing private credit funds and the role of research houses and financial advisers in this play.

“These organisations play an important role in the private credit ecosystem, especially in the wholesale and retail investor segments of the market,” ASIC wrote. “Their views are considered and often relied upon by investors who do not always have the skills to assess private credit offerings for themselves. As a result, these organisations hold considerable power and influence.”

Responding to the paper, Lonsec detailed its coverage of business, product, team, and process for each fund rating. These are then subdivided to cover governance, start-ups, vertical integration, expertise and independence, complexity of warehouse structure, resourcing, portfolio diversity, and risk management – areas that are described as being of “heightened risk”. 

In the case of private market funds specifically, these funds receive a greater weighting placed on the ‘product’ sector, which considers a fund’s liquidity and valuations – two factors particularly important in these types of products and were raised by ASIC’s report.

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Valuation governance practices as well as liquidity assessment were conducted, which include comment on mismatches, disclosure, and redemption mechanisms.

“Funds that fall short in these areas receive lower scores in our scoring model, while demonstrating strong governance and disclosure are recognised. Our overall opinion supporting the rating and commentary throughout the report will reflect a product’s relative strengths and weaknesses versus its peer group,” said Darrell Clark, deputy director of research and manager for alternatives.

“This approach ensures advisers and investors can identify which managers are adopting global best practice, and which may expose them to heightened governance or transparency risks.

“Where minimum standards are not met, Lonsec will not proceed to cover these managers.”

It maintained there is still a place for private credit in portfolios despite ASIC’s concerns, but agreed certain areas could be improved around factors such as transparency and governance. 

Clark said: “The private credit sector has genuine merit, but regulatory scrutiny has underscored the need for managers to strengthen areas such as conflict management, transparency, and governance practices. It is important to recognise that Australia’s private credit sector is still developing and strengthening these core areas will benefit investors and bridge the gaps to products offered offshore.

“As a research house, Lonsec Research and Ratings will continue to provide leadership via our ratings methodology which captures these risks, while holding managers to account and supporting advisers to aid their clients in making informed investment decisions. We will remain adaptable to evolving market dynamics and ASIC’s ongoing review to ensure our research approach remains aligned to best practice.”

Since ASIC’s report, four private credit funds have received interim stop orders from the regulator regarding their target market determinations and product dislosure statements.

The La Trobe order was imposed on 18 September by ASIC after concerns that the target market determination (TMD) for the 12-Month Term Account and 2-Year Account products suggested an inappropriate level of portfolio allocation given the risks of the fund and did not include appropriate distribution conditions.  Orders have since been lifted on the Australian Credit Fund.

Meanwhile, on the RELI Capital Mortgage Fund, the target market potentially included investors who intended to hold the fund as a ‘Core Component’ (25–75 per cent) of their portfolio, the fund’s risk level ‘Risk level 3 (Low to Medium)’ is an incomplete measure of the fund’s risk, the TMD states that the Fund is suitable for investors seeking capital preservation, and the TMD specifies that no distribution conditions are necessary for the fund.

Finally, in October, two share classes for the TruePillars Investment Fund, a registered managed fund run by TPRE, received orders as ASIC was concerned that its PDS omitted investment information, failed to disclose fees and costs, and contained misleading statements about income distribution, among others.