Their power over fund selection is only set to increase as more firms adopt centralised investment propositions
Fund research and rating agencies have enjoyed a buoyant market in advice firms thanks to the post-RDR rise of centralised investment propositions.
While a minority of advisers have chosen to outsource portfolio management, the majority are selecting funds themselves and running in-house model portfolios.
Advisers make use of research agencies in several ways: using research and ratings to create shortlists of funds and build model portfolios, buying in template portfolios and seeking out the assistance of their consultancy services. Four of the leading research agencies also offer discretionary managed portfolio services to advice firms.
Under the bonnet of fund research agencies
The vast majority of advisers who pick funds or run advisory models now use third-party research for their firms’ investment propositions, with our estimates putting research agencies’ potential influence at over two-thirds of total advised assets.
As it stands, charges and performance relative to sector are the most widely used metrics for advisers’ fund selection (see chart below), with just 34 per cent putting third-party ratings in their top five criteria. But we see this growing.
Advisers that do look at this metric are likely to screen out low-rated funds when they build shortlists or portfolios. Many also keep tabs on when their selected funds suffer a downgrade in rating. This could lead them to remove such funds from their shortlists and portfolios, or to place them on a watch list.
The leading research agencies’ ratings use different methodologies and their focus tends to be either mainly quantitative or qualitative.
Morningstar’s Star ratings and FE’s Crown ratings are purely quantitative and they only judge funds on the basis of key backwards-looking metrics like performance, consistency and alpha.
Morningstar also offers its qualitatively-driven Analyst ratings. This rating is largely based on interviews with the fund managers, aiming to understand their processes and objectives. Square Mile and The Adviser Centre also provide ratings that are largely qualitative and operate within a similar framework.
The qualitative overlay does not aim to pick just the best performing funds in their sectors but rather the funds with which advisers can have confidence will perform well in any given market backdrop.
Agencies that employ a blend of quantitative and qualitative research generally use the quantitative component as a screening process to narrow down the universe of funds. Their analysts can then conduct interviews with the fund managers and feed back to the rest of the team to complete the rating process.
Research agencies are all very keen to stress the independence of their ratings from the influence of the asset managers that pay their fees. The FCA raised concerns back in 2016 about agencies providing ratings on a “pay-to-play” basis.
But the agencies argue their commercial conversations with asset managers about licences usually take place after they have published their rating, or else they say there are Chinese walls between the research and commercial teams.
Agencies’ influence on the advice market will continue to grow as more and more firms adopt centralised investment propositions and lean on the expertise of third-party research and ratings.
Such agencies are already extending their influence through partnerships with many of the larger advice firms, networks and support service providers.
Asset managers reviewing their distribution strategies in the retail space should pay close attention to the large and growing power over fund selection these research agencies have achieved.
Andrew Ashwood is an analyst at Platforum. For more information on Platforum’s report, The Influence of Research Agencies, download an outline of the report here or contact email@example.com.